##### Table of Contents



U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended March 31, 2005
 o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934  Commission File Number
0-51110 VIACELL, INC. (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    04-3244816(State or Other Jurisdiction of Incorporation or
    
    (I.R.S. Employer Identification No.)Organization)245 First Street, Cambridge, MA
    
    02142(Address of Principal Executive Offices)
    
    (Zip Code)
 (617) 914-3400(Registrants telephone number, including area code)   Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes o No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). o Yes þ No As of May 11, 2005, 37,767,703 shares of the Companys common stock, $0.01 par value, were
outstanding.   1




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TABLE OF CONTENTS PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)Condensed Consolidated Balance Sheets  March 31, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations  Three months ended March 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Comprehensive Loss  Three months ended March 31, 2005 and 2004
    
    
    5Condensed Consolidated Statements of Cash Flows  Three months ended March 31, 2005 and 2004
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    46Item 4. Controls and Procedures
    
    
    47PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    47Item 2. Changes in Securities and Use of Proceeds
    
    
    49Item 5. Other Information
    
    
    50Establishment of Executive Management Bonus and Equity Awards for 2004 and Base Salary and Bonus Potential for 2005
    
    
    50Item 6. Exhibits
    
    
    51Signatures
    
    
    52EXHIBITSIndex to Exhibits
    
    
    53Ex-10.1 Development Agreement dated January 24, 2005Ex-10.2 Suppply Agreement dated January 24, 2005Ex-31.1 Section 302 Certification of CEOEx-31.2 Section 302 Certification of CFOEx-32.1 Section 906 Certification of CEOEx-32.2 Section 906 Certification of CFO
  2




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PART I  FINANCIAL INFORMATION 
 ITEM 1.FINANCIAL STATEMENTS ViaCell, Inc. 
 Condensed Consolidated Balance Sheets
 (in thousands)
 (unaudited)
 March 31, 2005
    
    
    December 31, 2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    40,528
    
    
    $
    6,746Short-term investments
    
    
    26,941
    
    
    
    21,339Accounts receivable, net
    
    
    12,176
    
    
    
    10,808Prepaid expenses and other current assets
    
    
    3,842
    
    
    
    4,928Total current assets
    
    
    83,487
    
    
    
    43,821Property and equipment, net
    
    
    7,309
    
    
    
    6,738Goodwill
    
    
    3,621
    
    
    
    3,621Intangible assets, net
    
    
    2,975
    
    
    
    3,025Long-term investments
    
    
    
    
    
    
    500Restricted cash
    
    
    1,944
    
    
    
    1,953Other assets
    
    
    1,006
    
    
    
    1,433Total assets
    
    $
    100,342
    
    
    $
    61,091LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Current portion of long-term debt obligations
    
    $
    1,771
    
    
    $
    1,743Accounts payable
    
    
    1,887
    
    
    
    1,271Accrued expenses
    
    
    8,135
    
    
    
    7,490Note payable to related party
    
    
    
    
    
    
    15,422Deferred revenue
    
    
    4,915
    
    
    
    3,458Total current liabilities
    
    
    16,708
    
    
    
    29,384Deferred revenue
    
    
    7,615
    
    
    
    6,728Deferred rent
    
    
    2,257
    
    
    
    1,036Contingent purchase price
    
    
    8,155
    
    
    
    8,155Long-term debt obligations, net of current portion
    
    
    1,120
    
    
    
    1,572Total liabilities
    
    
    35,855
    
    
    
    46,875Redeemable convertible preferred stock,
authorized 30,396,809 shares at December 31,
2004, issued and outstanding 0 and 25,628,075 at
March 31, 2005 and December 31, 2004,
respectively
    
    
    
    
    
    
    175,173Commitments and contingencies (Note 7)Stockholders equity (deficit):Convertible preferred stock, $0.01 par value;
authorized 5,000,000 and 428,191 shares at March
31, 2005 and December 31, 2004, respectively;
issued and outstanding 0 and 182,857 shares at
March 31, 2005 and December 31, 2004,
respectively
    
    
    
    
    
    
    2Common stock, $0.01 par value; authorized
100,000,000 and 80,000,000 shares at March 31,
2005 and December 31, 2004, respectively; issued
and outstanding 37,523,780 and 2,763,961 shares
at March 31, 2005 and December 31, 2004,
respectively
    
    
    373
    
    
    
    28Additional paid-in capital
    
    
    228,745
    
    
    
    Deferred compensation
    
    
    (2,096
    )
    
    
    (2,530
    )Accumulated other comprehensive income
    
    
    267
    
    
    
    309Accumulated deficit
    
    
    (162,802
    )
    
    
    (158,766
    )Total stockholders equity (deficit)
    
    
    64,487
    
    
    
    (160,957
    )Total liabilities, redeemable convertible
preferred stock and stockholders equity
(deficit)
    
    $
    100,342
    
    
    $
    61,091
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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ViaCell, Inc. 
 Condensed Consolidated Statements of Operations
 (in thousands, except per share data)
 (unaudited)
 Three Months Ended March 31,2005
    
    
    2004Processing and storage revenues
    
    $
    9,975
    
    
    $
    8,583Grant and contract revenues
    
    
    165
    
    
    
    436Total revenues
    
    
    10,140
    
    
    
    9,019Operating expenses:Cost of processing and storage revenues:Direct costs
    
    
    1,948
    
    
    
    1,818Royalty expense
    
    
    
    
    
    
    526Total cost of processing and storage revenues
    
    
    1,948
    
    
    
    2,344Research and development
    
    
    3,576
    
    
    
    3,986Sales and marketing
    
    
    5,491
    
    
    
    5,654General and administrative
    
    
    2,764
    
    
    
    3,368Stock-based compensation(1)
    
    
    436
    
    
    
    864Restructuring
    
    
    121
    
    
    
    Total operating expenses
    
    
    14,336
    
    
    
    16,216Loss from operations
    
    
    (4,196
    )
    
    
    (7,197
    )Interest income (expense):Interest income
    
    
    315
    
    
    
    146Interest expense
    
    
    (155
    )
    
    
    (394
    )Total interest income (expense), net
    
    
    160
    
    
    
    (248
    )Net loss
    
    
    (4,036
    )
    
    
    (7,445
    )Accretion on redeemable convertible preferred stock
    
    
    (987
    )
    
    
    (3,314
    )Net loss attributable to common stockholders
    
    $
    (5,023
    )
    
    $
    (10,759
    )Net loss per share:Net loss per common share, basic and diluted
    
    $
    (0.17
    )
    
    $
    (4.03
    )Weighted average shares used in basic and diluted net loss per share
computation
    
    
    29,719
    
    
    
    2,667
   (1)
    
    Allocation of stock-based compensation expense is as follows: Three Months Ended March 31,2005
    
    
    2004Cost of processing and storage revenues
    
    $
    5
    
    
    $
    8Research and development
    
    
    70
    
    
    
    326Sales and marketing
    
    
    78
    
    
    
    104General and administrative
    
    
    283
    
    
    
    426Total stock-based compensation expense
    
    $
    436
    
    
    $
    864
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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ViaCell, Inc. 
 Consolidated Statements of Comprehensive Loss (in thousands)
 (unaudited)
 Three Months Ended March 31,2005
    
    
    2004Net loss
    
    $
    (4,036
    )
    
    $
    (7,445
    )Foreign currency translation adjustment
    
    
    (42
    )
    
    
    (156
    )Comprehensive loss
    
    $
    (4,078
    )
    
    $
    (7,601
    )
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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ViaCell, Inc. 
 Condensed Consolidated Statements of Cash Flows (in thousands)
 (unaudited)
 Three Months Ended March 31,2005
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (4,036
    )
    
    $
    (7,445
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    514
    
    
    
    646Stock-based compensation
    
    
    436
    
    
    
    864Reserve for bad debt
    
    
    58
    
    
    
    (96
    )Non-cash interest expense on related party note payable
    
    
    87
    
    
    
    280Other
    
    
    22
    
    
    
    8Changes in assets and liabilities:Accounts receivable
    
    
    (1,156
    )
    
    
    (770
    )Prepaid expenses and other current assets
    
    
    1,198
    
    
    
    (963
    )Accounts payable
    
    
    623
    
    
    
    (2,243
    )Accrued expenses
    
    
    741
    
    
    
    955Deferred revenue
    
    
    2,343
    
    
    
    1,179Deferred rent
    
    
    1,222
    
    
    
    Net cash provided by (used in) operating activities
    
    
    2,052
    
    
    
    (7,585
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (1,035
    )
    
    
    (336
    )Proceeds from maturities of investments
    
    
    4,477
    
    
    
    2,576Purchase of investments
    
    
    (9,579
    )
    
    
    (22,244
    )Net cash used in investing activities
    
    
    (6,137
    )
    
    
    (20,004
    )Cash flows from financing activities:Proceeds from exercise of stock options and warrants
    
    
    622
    
    
    
    10Proceeds from issuance of common stock, net
    
    
    53,291
    
    
    
    Decrease in restricted cash
    
    
    
    
    
    
    (522
    )Repayments on credit facilities
    
    
    (431
    )
    
    
    (386
    )Repayment of note payable to related party
    
    
    (15,510
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    37,972
    
    
    
    (898
    )Effect of change in exchange rates on cash
    
    
    (105
    )
    
    
    (121
    )Net increase (decrease) in cash and cash equivalents
    
    
    33,782
    
    
    
    (28,608
    )Cash and cash equivalents, beginning of period
    
    
    6,746
    
    
    
    39,008Cash and cash equivalents, end of period
    
    $
    40,528
    
    
    $
    10,400Supplemental disclosures of cash flow information and
non cash transactionsInterest paid
    
    $
    152
    
    
    $
    94
 The accompanying notes are an integral part of these condensed consolidated financial statements. 6




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ViaCell, Inc. 
 Notes to Consolidated Financial Statements (unaudited)
 1. Organization and Nature of Business ViaCell, Inc. (the Company) was incorporated in the State of Delaware on September 2, 1994
as t.Breeders Inc. The Company was in the development stage until April 11, 2000 at which time the
Company completed a merger with Viacord, Inc. (Viacord), an umbilical cord blood collection,
processing and preservation company, and changed its name to ViaCell, Inc. The Company is a biotechnology company engaged in sourcing, developing and commercializing
cellular therapies to address cancer, cardiac disease, diabetes and infertility. ViaCells mission
is to enable the widespread application of human cells as medical therapy. ViaCells lead stem cell
product candidate, CB001, is manufactured using one of the Companys proprietary technologies,
which allows the isolation, purification and significant expansion of populations of stem cells,
and enables the production of well defined cellular products in therapeutically useful quantities.
The Company is developing CB001 for use in bone marrow and other hematopoietic stem cell
transplants. The Companys current commercialized service is Viacord, a leading brand in the
cryopreservation of umbilical cord stem cells, primarily for pediatric bone marrow
transplantations. In addition, the Company is developing a product expected to offer women the
ability to preserve or extend their fertility through the cryopreservation of their oocytes (eggs). The Company restructured its operations in September and December 2004 to reduce operating
expenses and concentrate its research and development resources on four key products and product
candidates, and related business initiatives (Note 10). On January 26, 2005, the Company completed its initial public offering (IPO). The Company
issued 8,625,000 shares of its common stock at $7.00 per share resulting in net proceeds to the
Company of approximately $53,300,000 after underwriters discounts and offering expenses. As a
result of the IPO, all outstanding shares of the Companys preferred stock immediately converted
into 25,810,932 shares of common stock. On January 26, 2005, the Company paid in full the related
party note of $15,509,760, which included all outstanding principal and interest owed at that date. 2. Summary of Significant Accounting Policies Basis of Presentation The financial information as of March 31, 2005 and for the three months ended March 31, 2005
and 2004, and related notes, are unaudited but in managements opinion include all adjustments,
consisting only of normal recurring adjustments, that the Company considers necessary for fair
statement of the interim periods presented. The Companys accounting policies are described in the
Notes to the Consolidated Financial Statements in our 2004 Annual Report on Form 10-K and updated,
as necessary, in this Form 10-Q. Results for the three months ended March 31, 2005 are not
necessarily indicative of results for the entire fiscal year or future periods. The accompanying
consolidated financial statements include the accounts of the Company and its wholly-owned
subsidiaries. All intercompany accounts and transactions have been eliminated. Certain
reclassifications of prior year amounts have been made to conform to current year presentation. 7




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Use of Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates. Redeemable Convertible Preferred Stock The carrying value of redeemable convertible preferred stock is increased by periodic
accretions, including cumulative dividends, so that the carrying amount will equal the redemption
amount at the earliest redemption date. These increases are effected through charges to additional
paid-in capital to the extent there are any and, thereafter, to accumulated deficit. All of the
Companys outstanding redeemable convertible preferred shares outstanding automatically converted
to the Companys common stock upon the completion of the initial public offering on January 26,
2005. There were no redeemable convertible preferred shares outstanding as of March 31, 2005. Stock-Based Compensation The Company uses the intrinsic value method of Accounting Principles Board Opinion No. 25
(APB No. 25), Accounting for Stock Issued to Employees,and related interpretations in accounting
for its employee stock options, and presents disclosure of pro forma information required under
SFAS No. 123, and SFAS No. 148, Accounting for Stock-Based Compensation. The Company accounts for equity instruments issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services,which require that such equity instruments are recorded at their fair value on
the measurement date. The measurement of stock-based compensation may be subject to periodic
adjustment as the underlying equity instruments vest. During the period ended March 31, 2005, the Company did not issue any options to employees
with an exercise price below fair market value. During the periods ended March 31, 2005 and 2004,
the Company recorded amortization of deferred compensation of approximately $434,000 and $787,000,
respectively. At March 31, 2005 and December 31, 2004 approximately $2,100,000 and $2,500,000,
respectively, of deferred stock compensation related to stock options remained unamortized. During the period ended March 31, 2005 and 2004, the Company recorded stock-based compensation
expense of approximately $2,000 and $77,000, respectively, related to options granted to
non-employees. Had all employee stock-based compensation expense been determined using the fair value method
and amortized on a straight-line basis over the vesting period of the related options consistent
with SFAS No. 123, the pro forma net loss per share would have been as follows (table in thousands,
except per share data): 8




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March 31, 2005
    
    
    March 31, 2004Net loss attributable to common stockholders as reported
    
    $
    (5,023
    )
    
    $
    (10,759
    )Add: employee stock-based compensation expense included in
reported net loss
    
    
    434
    
    
    
    787Deduct: total employee stock-based compensation expense
determined under fair value based method for all awards
    
    
    (1,078
    )
    
    
    (1,320
    )Pro forma net loss attributable to common stockholders
    
    $
    (5,667
    )
    
    $
    (11,292
    )Basic and diluted net loss per shareAs reported
    
    $
    (0.17
    )
    
    $
    (4.03
    )Pro forma
    
    $
    (0.19
    )
    
    $
    (4.23
    )
 The Company has computed the pro forma disclosures required under SFAS No. 123 for all stock
options granted to employees and directors of the Company as of March 31, 2005 and 2004 using the
Black-Scholes option pricing model prescribed by SFAS No. 123. The weighted average assumptions used for the three months ended March 31 are as follows: 2005
    
    
    2004Risk-free interest rate
    
    
    4.17
    %
    
    
    2.86
    %Expected life
    
    5 years
    
    5 yearsExpected volatility
    
    
    100
    %
    
    
    100
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
 Segment Information The Companys management currently uses consolidated financial information in determining how
to allocate resources and assess performance. The Company may organize its business into more
discrete business units when and if it generates significant revenue from the sale of stem cell
therapies. For these reasons, the Company has determined that it conducts operations in one
business segment. The following table presents total long-lived tangible assets by geographic areas as of March
31, 2005 and December 31, 2004, respectively (table in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Long-lived assetsUnited States
    
    $
    6,893
    
    
    $
    6,310Germany
    
    
    88
    
    
    
    88Singapore
    
    
    328
    
    
    
    340Total long-lived tangible assets
    
    $
    7,309
    
    
    $
    6,738
 The following table presents revenues by geographic area for the three months ended March 31,
2005 and 2004, respectively (table in thousands): March 31,
    
    
    March 31,Revenues
    
    2005
    
    
    2004United States
    
    $
    10,013
    
    
    $
    8,713Germany
    
    
    (40
    )
    
    
    251Singapore
    
    
    167
    
    
    
    55Total Revenue
    
    $
    10,140
    
    
    $
    9,019
 9




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Net Loss Per Common Share Basic net loss per share is computed by dividing net loss attributable to common stockholders
by the weighted average number of shares of common stock outstanding during the period. Diluted net
loss per share is computed by dividing the net loss attributable to common stockholders for the
period by the weighted average number of common and potentially dilutive common shares outstanding
during the period. Potentially dilutive common shares consist of the common shares issuable upon
the exercise of stock options and warrants and the conversion of convertible preferred stock (using
the if-converted method). Potentially dilutive common shares are excluded from the calculation if
their effect is anti-dilutive. The following sets forth the computation of basic and diluted net loss per share (table in
thousands, except per share data); Three Months Ended March 31,2005
    
    
    2004Basic and diluted net loss per share:Net loss attributable to common stockholders
    
    $
    (5,023
    )
    
    $
    (10,759
    )Weighted average number of common shares outstanding
    
    
    29,719
    
    
    
    2,667Basic and diluted net loss per share
    
    $
    (0.17
    )
    
    $
    (4.03
    )
 The following potentially dilutive securities were excluded because their effect was
antidilutive: Three Months Ended March 31,2005
    
    
    2004Options
    
    
    4,085,046
    
    
    
    4,703,600Warrants
    
    
    1,420,833
    
    
    
    1,428,750Convertible preferred stock
    
    
    
    
    
    
    25,810,932
 Recent Accounting Pronouncements On
December 16, 2004, the FASB released SFAS No. 123(R). This new accounting standard
requires all forms of stock compensation, including stock options, to be reflected as an expense in
the Companys financial statements. Public companies must adopt the standard by their first annual
fiscal period beginning after June 15, 2005. The Company intends to apply the revised standard
beginning with the quarter ending March 31, 2006. Although the Company has not finalized its
analysis, it expects that the adoption of the revised standard will result in higher operating
expenses and loss per share. Note 2 to the consolidated financial statements shows the pro-forma
impact on net loss and net loss per common share as if the Company had historically applied the
fair value recognition provisions of SFAS No. 123 to stock based employee awards. In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47). FIN 47 clarifies the
term conditional asset retirement obligationas used in FASB Statement No. 143, Accounting for
Asset Retirement Obligations,referring to a legal obligation to perform an asset retirement
activity. Accordingly, an entity is required to recognize a liability for the fair value of a
conditional asset retirement obligation if the fair value of the liability can be reasonably
estimated. The provisions of FIN 47 are effective no later than the end of fiscal years ending
after December 15, 2005. The Company will adopt this standard for asset retirement activity in the
event that these types of transactions are entered into by the Company in future periods. 10




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3. Property and Equipment Property and equipment consisted of (table in thousands): March 31,
    
    
    December 31,2005
    
    
    2004Software
    
    $
    2,709
    
    
    $
    2,700Laboratory equipment
    
    
    4,547
    
    
    
    4,675Office and computer equipment
    
    
    2,249
    
    
    
    1,867Leasehold improvements
    
    
    3,129
    
    
    
    3,129Furniture and fixtures
    
    
    717
    
    
    
    717Construction in progress
    
    
    1,152
    
    
    
    380Property and equipment, gross
    
    
    14,503
    
    
    
    13,468Less: accumulated depreciation
and amortization
    
    
    (7,194
    )
    
    
    (6,730
    )Property and equipment, net
    
    $
    7,309
    
    
    $
    6,738
 At March 31, 2005 and December 31, 2004, equipment held under capital leases totaled
approximately $475,000, and accumulated depreciation related to this leased equipment totaled
approximately $270,000 and $251,000, respectively. Depreciation and amortization expense on property and equipment totaled approximately $464,000
and $575,000 for the three months ended March 31, 2005 and 2004, respectively. 4. Intangible Assets and Goodwill Intangible assets consist of a trademark and goodwill. Goodwill, which represents the excess
of purchase price over the fair value of net assets acquired, was amortized on a straight-line
basis over its useful life of ten years prior to January 1, 2002. Amortization of intangible assets was approximately $50,000 and $74,000 for the three months
ended March 31, 2005 and 2004, respectively. At March 31, 2005 and December 31, 2004, ViaCells intangible assets consisted of the
following (table in thousands); March 31,
    
    
    December 31,2005
    
    
    2004Intangible assets:Trademark
    
    $
    4,400
    
    
    $
    4,400Less: accumulated amortization
    
    
    (1,425
    )
    
    
    (1,375
    )Intangible assets, net
    
    $
    2,975
    
    
    $
    3,025
 The Company expects amortization of these intangible assets to be approximately $202,000
annually through 2019, at which point they will be fully amortized. 11




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5. Accrued Expenses At March 31, 2005 and December 31, 2004, accrued expenses consisted of the following (table in
thousands): March 31,
    
    
    December 31,2005
    
    
    2004Payroll and payroll related
    
    $
    880
    
    
    $
    1,016Management incentive
    
    
    271
    
    
    
    723Professional fees
    
    
    2,756
    
    
    
    2,027Accrued marketing
    
    
    1,024
    
    
    
    912Accrued restructuring
    
    
    756
    
    
    
    907Other
    
    
    2,448
    
    
    
    1,905$
    8,135
    
    
    $
    7,490
 6. Long-Term Obligations The Company had the following long-term debt outstanding as of March 31, 2005 and December 31,
2004 (table in thousands): March 31, 2005
    
    
    December 31, 2004Debt facility loans
    
    $
    2,734
    
    
    $
    3,136Related party note payable
    
    
    
    
    
    
    15,422Capital lease obligations
    
    
    157
    
    
    
    179Total long-term debt
    
    
    2,891
    
    
    
    18,737Less: current portion
    
    
    (1,771
    )
    
    
    (17,165
    )Total long-term debt, net of
current portion
    
    $
    1,120
    
    
    $
    1,572
 Note Payable to Related Party A portion of the consideration paid by the Company in its acquisition of Kourion Therapeutics
consisted of promissory notes in an aggregate principal amount of $14.0 million. The notes were
held by several funds that are also stockholders of the Company and that are affiliated with MPM
Asset Management LLC, the manager of which serves on the Companys board of directors. The notes
bore interest at a rate of 8% per annum, compounded annually, and were to mature on September 30,
2007. They were subject to mandatory prepayment upon the earlier of an initial public offering of
the Companys common stock or a sale of the Company. The total outstanding principal and unpaid
accrued interest on the notes as of December 31, 2004 was $15,422,000. On January 26, 2005,
following the completion of its initial public offering, the Company paid off these related party
notes totaling of $15,510,000, which included all outstanding principal and interest owed at that
date. 7. Commitments and Contingencies Leases The Company conducts its operations in leased facilities under non-cancelable operating leases
expiring through 2014. Future minimum rental payments under the operating leases are approximately as follows (table
in thousands): 12




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##### Table of Contents



Year Ending December 31,2005
    
    $
    2,0222006
    
    
    1,8892007
    
    
    1,9322008
    
    
    1,7592009
    
    
    1,704Thereafter
    
    
    8,042Total lease payments
    
    $
    17,348
 Rent expense was approximately $531,000 and $499,000 for the three months ended March 31, 2005
and 2004, respectively. Agreements In January 2005, the Company entered into development and supply agreements with Miltenyi
Biotec GmbH. The development agreement provides for the development by Miltenyi of a cGMP cell
separation kit (the Product) for ViaCell consisting of various antibodies conjugated with
magnetic particles to be used in ViaCells Selective Amplification process for the development and
commercialization of ViaCells therapeutic cellular therapy products based on the Selective
Amplification technology. Under the development agreement, Miltenyi is obligated to perform
various tasks set forth in the agreement in connection with the development of the Product,
including making various filings with the FDA. The Company is obligated to pay up to $950,000.
As of March 31, 2005, the Company had paid $700,000 relating to this development program, and will
recognize the payments ratably over the expected development period. The remaining $250,000 is a
milestone to be paid upon filing with the FDA. The term of the agreement ends on the earlier of the
expiration of both parties obligations under the development agreement and January 24, 2007. The supply agreement provides for the exclusive supply of the Product by Miltenyi to ViaCell.
The initial term of the supply agreement is for seven years. The Company has guaranteed minimum
purchase requirements totaling at least $1.6 million within the first year after the process
development program has been completed. Also, the Company has certain minimum annual purchase
requirements starting in fiscal 2007 which will apply if CB001 continues in clinical trials or is
commercialized. In August 2002, the Company entered into a license agreement with Massachusetts Institute of
Technology (MIT) under which the Company receives exclusive, worldwide rights to products based on
patents (currently pending) pertaining to a novel molecule invented by Dr. Ram Sasisekharan for
treatment of neurological disorders, including stroke. The Company terminated this agreement in
February 2005. The Company has no future commitments or obligations under this agreement as of
March 31, 2005. The Company has entered into an agreement with Economic Development Board of the government of
Singapore to provide no more than $4,000,000 to fund stem cell research and development programs
conducted in Singapore. Under this agreement, the government of Singapore reimburses a portion of
these expenses under a grant. The Company funded $296,000 and $181,000 of research and development
in Singapore during the three months ended March 31, 2005 and 2004, respectively, and recorded
grant revenue of $167,000 and $54,800 during the three months ended March 31, 2005, and 2004,
respectively. The Company enters into indemnification provisions under its agreements with other companies
in the ordinary course of business, typically with business partners, licensors and clinical sites.
Under these provisions, the Company generally indemnifies and holds harmless the indemnified party
for losses suffered or incurred by the indemnified party as a result of its activities. Certain
indemnification 13




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##### Table of Contents



provisions survive termination of the underlying agreement. The maximum potential amount of
future payments the Company could be required to make under these indemnification provisions is
unlimited. However, to date the Company has not incurred material costs to defend lawsuits or
settle claims related to these indemnification provisions. As a result, the estimated fair value of
these agreements is minimal. Accordingly, the Company has no liabilities recorded for these
agreements as of March 31, 2005. Litigation The Company was sued by PharmaStem Therapeutics, Inc. for allegedly infringing two patents
relating to the Companys Viacord umbilical cord stem cell cryopreservation business after the
Company rejected PharmaStems initial requests seeking a license arrangement because the Company
believes that the Company does not infringe these patents and that they are invalid. PharmaStem
filed a complaint in early 2002 against ViaCell and several other defendants in the United States
District Court for the District of Delaware, alleging infringement of US Patents No. 5,004,681 and
No. 5,192,553, relating to certain aspects of the collection, cryopreservation and storage of
hematopoietic stem cells and progenitor cells from umbilical cord blood. In 2003, the jury ruled
against the Company and the other defendants, Cbr Systems, CorCell and Cryo-Cell, who represent a
majority of the family cord blood preservation industry, and a judgment was entered against ViaCell
for approximately $2.9 million, based on 6.125% royalties on the Companys revenue from the
processing and storage of umbilical cord blood since April 2000. In 2004, the Delaware Court overturned the judgment against ViaCell on the 553 method patent,
ruling that the Company did not infringe the patent. Regarding the 681 composition patent, the
Court initially vacated the verdict and ordered a new trial on infringement and damages (if any),
in connection with which, PharmaStem sought a preliminary injunction. However, the Court
subsequently reversed its ruling, overturning the jurys verdict of infringement of the 681 patent
and denying PharmaStems motion for preliminary injunction. On January 6, 2005, PharmaStem filed
a Notice of Appeal and a Motion to Expedite the Appeal of the Courts decision. On February 15,
2005, that Motion to Expedite the Appeal was denied. PharmaStems appeal brief was filed on March
22, 2005, and ViaCells appeal brief is due May 16, 2005. In August 2004, the US Patent and Trademark Office (US PTO) ordered the re-examination of both
the 553 method patent and the 681 composition patent based on the prior art. On February 2, 2005,
the PTO issued an Office Action rejecting all claims of the 553 patent as invalid over prior art. Should the US PTO find the claims of these patents to be unpatentable, then the litigation
proceedings between ViaCell and PharmaStem with respect to the unpatentable claims would cease. If
the Courts judgment as to non-infringement of the 553 or 681 patent is reversed on appeal and if
the Company is subsequently enjoined from further engaging in its umbilical cord stem cell
cryopreservation business, the Company will not be able to conduct this business unless PharmaStem
grants a license to the Company, which PharmaStem previously informed the Company that it would not
do after October 15, 2004. While the Company does not believe this outcome is likely, if, in the event
of an injunction, ViaCell is not able to obtain a license under the disputed patents or operate
under an equitable doctrine known as intervening rights, the Company will be required to stop
preserving and storing cord blood and to cease using cryopreserved umbilical cord blood as a source
for stem cell products. PharmaStem also filed a complaint against the Company in July 2004 in the United States
District Court for the District of Massachusetts, alleging infringement of US Patents No. 6,461,645
and 6,569,427, which also relate to certain aspects of the collection, cryopreservation and storage
of hematopoietic stem cells and progenitor cells from umbilical cord blood. By agreement of the
parties, ViaCell responded to the complaint on December 16, 2004. The Company continues to believe
that the patents in this new Massachusetts action are invalid and that the Company does not
infringe them in any event. On January 7, 2005, PharmaStem filed a Motion for Preliminary
Injunction in the Massachusetts 14




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##### Table of Contents



litigation. That Motion is currently stayed. If this Motion is granted, the Company could be
enjoined from collecting and storing cord blood that had not been collected as of the date the
injunction is issued while the case is litigated and thereafter if the Company loses the case.
ViaCell believes that the issues presented in PharmaStems Motion are substantially the same as the
issues presented in the Delaware litigation and, while no assurance can be given, the Company
believes that PharmaStems Motion will be denied. If the Company is ultimately found to infringe,
it could have a significant damages award entered against it, and ViaCell could also face an
injunction which could prohibit it from further engaging in the umbilical cord stem cell business
absent a license from PharmaStem on the disputed patents. The Company believes the issues
presented in this case are substantially the same as the issues presented in the Delaware
litigation. Accordingly, the Company filed a motion to consolidate the Massachusetts case with six
other actions against other defendants in a single proceeding in the District of Delaware. On
January 21, 2005, the Massachusetts case was stayed pending a ruling on this request. On February
16, 2005, the Companys request was granted. The cases have thus been consolidated in Delaware. In April 2005, the US PTO ordered re-examination of some claims of the patents at issue in the
second litigation, the 645 and 427 patents, based on the prior art. A request for re-examination
of other claims of those patents was denied. The timing and order of the litigations involving ViaCell and PharmaStem are not presently
known. Decisions in the re-examination proceedings of the 681, 553, 645, and 427 patents, now
pending before the US PTO, may also affect these factors. The Company may enter into settlement negotiations with PharmaStem regarding its litigation
with PharmaStem. The Company cannot predict whether any such negotiations would lead to a
settlement of these lawsuits or what the terms or timing of any such settlement might be, if it
occurs at all. On May 13, 2004, the Company received a First Amended Complaint filed in the Superior Court of
the State of California by Kenneth D. Worth, by and for the People of the State of California, and
naming as defendants a number of private cord blood banks, including ViaCell. The complaint alleges
that the defendants have made fraudulent claims in connection with the marketing of their cord
blood banking services and seeks restitution for those affected by such marketing, injunctive
relief precluding the defendants from continuing to abusively and fraudulently market their
services and requiring them to provide certain information and refunds to their customers,
unspecified punitive and exemplary damages and attorneys fees and costs. On October 7, 2004, the
Court orally granted a motion to strike the complaint under the California anti-SLAPP statute and
dismissed the complaint as to all defendants without leave to amend. Judgment has been entered,
dismissing the complaint, and plaintiff has filed a notice of appeal and a petition for a writ of
mandate. The petition has been dismissed and the appeal is proceeding. The Company believes that
the plaintiff is in the process of negotiating a settlement with all defendants other than the
Company. The Company is not yet able to conclude as to the likelihood that plaintiffs claims
would be upheld if the judgment of dismissal were reversed on appeal, nor can it estimate the
possible financial consequences should plaintiff prevail. However, the Company believes this suit
to be without merit and intends to continue to vigorously defend itself. On February 24, 2005, Cbr Systems, Inc., a private cord blood banking company, filed a
complaint against the Company in the United States District Court for the Northern District of
California alleging false and misleading advertising by the Company in violation of the federal
Lanham Act and various California statutes and common law and seeking an injunction from continuing
such advertising and unspecified damages. On April 13, 2005, the Company answered the complaint,
denying Cbrs allegations, and filed counterclaims alleging false and misleading advertising by
Cbr. The Companys counterclaims seek an injunction and damages, and the Company intends to
vigorously defend itself in this action. 15




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The Company periodically becomes subject to legal proceedings and claims arising in connection
with its business. With the exception of the PharmaStem complaint noted above, the Company does not
believe that there were any asserted claims against it as of March 31, 2005 which, if adversely
decided, would have a material adverse effect on results of operations, financial position or cash
flow. 16




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##### Table of Contents



8. Redeemable Convertible Preferred Stock, Preferred Stock, and Stockholders Deficit All of the Companys redeemable convertible preferred stock and preferred stock converted to
common stock upon closing the Companys initial public offering on January 26, 2005. The Companys
redeemable convertible preferred stock is accreted to redemption value and consisted of the
following as of March 31, 2005 and December 31, 2004, respectively (table in thousands, except for
share data): March 31, 2005
    
    
    December 31,2004Series C, $0.01 par valueAuthorized,
issued and outstanding;
 0 and
919,220 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    $
    
    
    
    $
    1,587Series D, $0.01 par valueAuthorized, issued and outstanding; 0 and
1,500,000 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    
    
    
    
    
    3,886Series E, $0.01 par valueAuthorized, issued and outstanding; 0 and
1,983,334 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    
    
    
    
    
    9,172Series F, $0.01 par valueAuthorized, issued and outstanding; 0 and
2,666,666 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    
    
    
    
    
    11,514Series G, $0.01 par valueAuthorized, issued and outstanding; 0 and
3,666,667 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    
    
    
    
    
    15,831Series H, $0.01 par valueAuthorized, issued and outstanding; 0 and
7,577,334 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    
    
    
    
    
    66,460Series I, $0.01 par valueAuthorized, 5,575,000 shares; issued and
outstanding; 0 and 2,624,854 shares at
March 31, 2005 and December 31, 2004,
     respectively
    
    
    
    
    
    
    25,975Series J, $0.01 par valueAuthorized, 3,750,000 shares; issued and
outstanding; 0 and 2,190,000 shares at
March 31, 2005 and December 31, 2004,
     respectively
    
    
    
    
    
    
    17,958Series K, $0.01 par valueAuthorized, issued and outstanding; 0 and
2,500,000 shares at March 31, 2005 and
December 31, 2004,     respectively
    
    
    
    
    
    
    22,790Total redeemable convertible preferred stock
    
    $
    
    
    
    $
    175,173
 17




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##### Table of Contents



The Companys redeemable convertible preferred stock activity for period ended March 31, 2005
consisted of the following (table in thousands): Balance December 31, 2004
    
    $
    175,173Issuance of SharesAccretion to Redemption Value
    
    
    987Conversion to Common Stock
    
    
    (176,160
    )Balance March 31, 2005
    
    $
    0
 The Companys convertible preferred stock consisted of the following as of March 31, 2005 and
December 31, 2004, respectively: March 31,
    
    
    December 31,2005
    
    
    2004Series A, $0.01 par valueAuthorized, issued and outstanding  100,000
shares (liquidation preference of $100,000 at
December 31, 2004 )
    
    $
    0
    
    
    $
    1,000Series B, $0.01 par valueAuthorized, issued and outstanding  82,857
shares (liquidation preference of $145,000 at
December 31, 2004)
    
    
    0
    
    
    
    829Total convertible preferred stock
    
    $
    0
    
    
    $
    1,829
 In connection with the September 2003 acquisition of Kourion, the Company issued 241,481
shares to an escrow account and reserved 289,256 shares for possible future issuance. These shares
will be released and issued if there occurs a change in control of the company. If that event does
not occur prior to September 30, 2006, the escrow shares will revert back to the Company and the
reserved shares will not be issued. In connection with the shares of Series K convertible preferred stock issued to Amgen and the
current PharmaStem litigation, the Company has a side agreement under which Amgen has a one-time
option to require the Company to redeem up to 1,250,000 of its Series K shares at a price of $8.00
per share. This option is triggered upon the occurrence of the earliest of June 23, 2007, a
settlement or final judgment against the Company for a total amount exceeding $30 million
(including the initial judgment amount as well as certain royalties, if any, that the Company
becomes obligated to pay PharmaStem), or an injunction enjoining the Companys cord blood
preservation operations that has not been stayed or vacated. This option expires upon the earliest
of the second anniversary of the triggering event, a settlement or final judgment against the
Company for a total amount less than or equal to $30 million (provided that an injunction is not
currently in effect at the time), or a public offering of the Companys common stock in which all
outstanding shares of convertible preferred stock of the Company automatically convert into common
stock. All preferred stock immediately converted to common stock upon the completion of the
Companys initial public offering and therefore this Amgen option terminated (See note 11). Preferred Stock Upon the closing of the Companys initial public offering (IPO) on January 26, 2005, the
Company amended its charter to provide for the authorization of 5,000,000 shares of undesignated
preferred stock, par value $0.01 per share. As of March 31, 2005, none of such preferred stock has
been designated and no shares are outstanding. 18




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##### Table of Contents



Common Stock As of March 31, 2005 and December 31, 2004, the Company has authorized 100,000,000 and
80,000,000 shares of common stock, respectively, with a $0.01 par value each. Each holder of a
share of common stock is entitled to one vote for each share held at all meetings of stockholders. 9. Warrants In 2003, the Company issued 2,190,000 of its Series J convertible preferred stock for total
gross proceeds to the Company of $17,520,000. A right to contingent warrants was granted to all
purchasers of Series J preferred stock (the Series J investors). Under that right, upon the
earlier to occur of an initial public offering that is not a Qualified Public Offering (an initial
public offering at a minimum price of $9.70 per share in which net proceeds equal or exceed $50
million) or the three year anniversary of the Initial Closing (September 30, 2006), the Company
would be required to issue warrants to the Series J investors for the purchase of Common Stock
equal to the number of shares owned of Series J (2,190,000 shares). The initial warrant purchase
price would be $5.00. Under the warrant issuance right, the warrant price and number of shares
purchasable would have been adjustable from time to time based on specific criteria to prevent
dilution; no such adjustments were made. The right to the contingent warrants had a fair value of
approximately $1,620,000 at the time of grant. The fair value was estimated using a binomial
valuation model. The Company recorded the Series J convertible preferred stock and the
contingent warrants, at their relative fair values of $15,622,000 and $1,390,000,
respectively. In January 2005, the Company completed its initial public offering. Since the
offering was not a Qualified Public Offering, the Company issued warrants to purchase a total of
2,190,000 shares of Common Stock to the Series J investors in February 2005. In October 2003, in connection with a debt financing, the Company issued to the lender a
warrant to purchase 18,750 shares of the Companys Series J preferred stock at an exercise price of
$8.00 per share. The warrant had a term of 10 years. In February 2005, the warrant was fully
exercised using a net exercise feature that resulted in the issuance of 4,571 shares of our
Common Stock in consideration of canceling the remaining portion of the warrant covering 14,179
shares. 10. Restructuring In September 2004, the Company restructured its operations to reduce operating expenses and
concentrate its resources on four key products and product candidates, and related business
initiatives. These products and product candidates consist of Viacord, Viacyte, CB001 and the
cardiac development program. As a result, the Company recorded a $1.7 million restructuring charge
in the third quarter of 2004 related to employee severance, contract termination costs and the
write-down of excess equipment. The majority of the contract termination costs related to the
Company exercising the termination provision in its agreement with Gamete Technologies, under which
the Company was required to pay $175,000 to Gamete Technologies. In December 2004, the Companys
Board voted to restructure the Companys German operations and sublet its laboratory facility in
Germany to a third party effective January 1, 2005. As a result, the Company recorded an additional
restructuring charge of $1.2 million in the fourth quarter of 2004, including facility related
costs of $1.1 million and $0.1 million related to a contract termination fee. The majority of the
facility related costs consisted of the write off of the leasehold improvements and fixed assets in
the Companys German facility, as well as the future minimum lease payments related to the
facility. The amount of this write off was partially reduced by the minimum future lease payments
receivable from the sublessee. At December 31, 2004, restructuring costs of $1.2 million were paid
out, the net book value of fixed assets was written down by $0.9 million and the accrued liability
relating to the restructurings was $0.9 million. During March 2005, the Company revised its
restructuring assumptions associated with the closure of its German facility in December 2004. In
March 2005, the Company was notified that approximately $160,000 in grant proceeds related to fixed
asset expenditures were not reimbursable under the grant and would have to be repaid. The 19




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Company recorded a reversal of approximately $44,000 in grant revenue and $121,000 in restructuring
expense, as that portion had not been recognized as grant revenue prior to December 31, 2004. The
Company is in the final stages of finalizing the fiscal 2004 grant reimbursements and considers it
unlikely that any further adjustment is necessary as of March 31, 2005. The accrued liability
related to restructuring as of March 31, 2005 was approximately $756,000. December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    March 31,(In Thousands)
    
    2004
    
    
    Additions
    
    
    Writedowns
    
    
    Adjustments
    
    
    Payments
    
    
    2005Severance related
    
    $
    421
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (290
    )
    
    $
    131Contractual terminations
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    165
    
    
    
    (2
    )
    
    
    168Facility related
    
    
    481
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (24
    )
    
    
    457$
    907
    
    
    $
    
    
    
    $
    
    
    
    $
    165
    
    
    $
    (316
    )
    
    $
    756
 11. Initial Public Offering On January 26, 2005, the Company completed its initial public offering (IPO). The Company
issued 8,625,000 shares of its common stock at $7.00 per share resulting in net proceeds to the
Company of approximately $53,300,000 after underwriters discounts and offering expenses. As a result
of the IPO, all outstanding shares of the Companys preferred stock immediately converted into
25,810,932 shares of common stock. On January 26, 2005, the Company paid in full the related party
note of $15,509,760, which included all outstanding principal and interest owed at that date. 
 ITEM 2.MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements The information set forth in this report in Item 2, Managements Discussion and Analysis of
Financial Condition and Results of Operations, and Item 3, Quantitative and Qualitative
Disclosure about Market Risk, includes forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and is subject to the
safe harbor created by that section. Such statements may include, but are not limited to,
projections of revenues, income or loss, capital expenditures, plans for product development and
cooperative arrangements, future operations, financing needs or plans of ViaCell, as well as
assumptions relating to the foregoing. The words believe, expect, will, anticipate,
estimate, project, plan, and similar expressions identify forward-looking statements, which
speak only as of the date the statement was made. Factors that could cause results to differ
materially from those projected or implied in the forward-looking statements are set forth below
under the caption Risk Factors Relating to ViaCells Business. Overview We are a biotechnology company dedicated to enabling the widespread application of human cells
as medicine. To date, the widespread application of human cells as medicine has not been proven to
be possible. We are in an early stage of development for our cellular therapeutic products, and we
are developing a pipeline of proprietary product candidates intended to address cancer, cardiac
disease, diabetes and infertility, and a commercial business dedicated to the preservation of
umbilical cord blood. Our research and development efforts focus primarily on developing cord
blood-derived stem cell product candidates in therapeutically useful quantities. CB001, our lead
stem cell therapy product candidate, is currently in a Phase 1 clinical trial. We are developing
applications of a proprietary type of stem cell called Unrestricted Somatic Stem Cells (USSCs) for
the treatment of cardiac disease. In 20




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addition, we have a research stage program in collaboration
with Genzyme targeting applications in diabetes. We are also developing Viacyte, a product
candidate for cryopreserving and storing human oocytes. Since our inception on September 2, 1994,
our principal activities have included:  
    developing our Selective Amplification and other stem cell therapy technologies;
    expanding our ViaCell Reproductive Health franchise in the United States;
    expanding our pipeline of novel stem cell and other product candidates through internal
development, and the acquisition of third party technologies;
    expanding and strengthening our intellectual property position through internal
programs, third party licenses, and acquisitions;
    recruiting management, research, clinical, and sales and marketing personnel; and
    forming alliances with larger, more experienced biotechnology and pharmaceutical
companies, including Amgen. As of March 31, 2005, our accumulated deficit was approximately $162.8 million. From inception
through March 31, 2005, we have raised $191.1 million in common and preferred stock issuances,
which includes $53.3 million in net proceeds from our initial public offering in January 2005. We
have incurred net losses since inception as a result of research and development, sales and
marketing and general and administrative expenses in support of our operations. We anticipate
incurring net losses for at least the next several years due to:  
    the increasing costs of conducting clinical trials for our lead hematopoietic stem cell
product candidate, CB001;
    the working capital costs associated with anticipated growth of our ViaCell
Reproductive Health franchise within the United States;
    the increasing costs associated with preclinical and clinical studies for our other
stem cell therapy product candidates; and
    the increasing costs associated with the development of Viacyte, our oocyte
cryopreservation product candidate. Our financial success will depend on many factors, including our ability to grow our umbilical
cord blood preservation business, establish the safety and efficacy of our therapeutic product
candidates, obtain necessary regulatory approvals and successfully commercialize new products. Our management currently uses consolidated financial information in determining how to
allocate resources and assess performance. We may organize our business into more discrete business
units when and if we generate significant revenue from the sale of stem cell therapies. For these
reasons, we have determined that we conduct operations in one business segment. The majority of our
revenue since inception has been generated in the United States, and the majority of our long-lived
assets are located in the United States. Revenues Our current revenue is derived primarily from fees charged to families for the preservation
and storage of a childs umbilical cord blood collected at birth. These fees consist of an initial
fee for 21




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collection, processing and freezing of the umbilical cord blood and an annual fee for
storage. The annual storage fee provides a growing annuity of future revenue as the number of
stored cords increases. Our revenues are recorded net of discounts and rebates that we offer our
customers under certain circumstances from time to time. Our revenues have increased substantially
over the last several years as the concept of cord blood banking has gained popularity. We offer
our customers the opportunity to pay their fees directly to us or to finance them via G.E. Capital,
a third party credit provider. Since we finance some receivables ourselves, we assume the risk of
losses due to unpaid accounts. We maintain a reserve for doubtful accounts to allow for this
exposure and consider the amount of this reserve to be adequate at March 31, 2005. Following the
September and December 2004 rulings of the district court in the ongoing patent litigation with
PharmaStem Therapeutics, Inc., which overturned the jury verdict of infringement on both PharmaStem
patents at issue in such suit, we do not expect the PharmaStem litigation to have a materially
adverse impact on our net sales, revenues or income from continuing operations. However, should we
ultimately lose this litigation, it could have a material adverse effect on our net sales, revenue
or income from continuing operations. In addition to the revenue generated by our Viacord product, we recorded revenue from grant
agreements with the governments of Singapore and Germany. We maintain a research facility in
Singapore. We decided to close our German research facility in December 2004, and have
transitioned the research activities that had been performed there to the United States. Therefore, revenue
from grants in Germany has ceased as of December 31, 2004. Operating Expenses Cost of revenues reflects the cost of transporting, testing, processing and storing umbilical
cord blood at our cord blood processing facility in Hebron, Kentucky, as well as a royalty to
PharmaStem relating to ongoing patent infringement litigation. Our cost of revenues also includes
expenses incurred by third party vendors relating to the transportation of cord blood to our
processing facility and certain assay testing performed on the cord blood before preservation.
Other variable costs include collection materials, labor, and processing and storage supplies,
while other fixed costs include rent, utilities and other general facility overhead expenses. Cost
of revenues does not include costs associated with our grant revenue. Such costs are included in
research and development expense. We recorded a royalty expense of approximately $3.3 million in the fourth quarter of 2003
following an unfavorable jury verdict in October 2003. This expense included a royalty of
approximately $2.9 million on revenues from cord blood preservation through October 29, 2003, plus
an accrual of a royalty of 6.125% of subsequent revenues through December 31, 2003. We recorded an
additional royalty expense of $0.5 million for the three months ended March 31, 2004, also based on
6.125% of revenues. In September 2004, the court overturned the jury verdict on one of the two
patents in litigation and vacated the verdict and granted a new trial concerning infringement and
damages, if any, on the second patent. Based on the judges ruling, we reversed the entire royalty
accrual of $3.8 million in the quarter ended June 30, 2004 and have not recorded any royalties
since. Pending further action by the courts, including the separate action recently filed in
Massachusetts, we do not intend to record a royalty expense in future periods, since we believe
PharmaStems claims are without merit. It is possible that the final outcome of these litigations
could result in damages payable regarding PharmaStems patents, at a higher or lower amount than
previously awarded by the jury in Delaware. Should this occur, our financial position and results
of operations could be materially affected. In addition, we may enter into settlement negotiations
with PharmaStem regarding our litigation with PharmaStem. If a settlement agreement were entered
into, we do not know whether it would provide for a payment by us of an ongoing royalty or payment
of other amounts by us to PharmaStem, or what those amounts might be. 22




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##### Table of Contents



Our research and development expenses consist primarily of costs associated with our lead stem
cell product candidate, CB001, and the continued development of our technologies, including
Selective Amplification, other cellular therapy product candidates and oocyte cryopreservation.
These expenses represent both clinical development costs and costs associated with non-clinical
support activities such as toxicological testing, manufacturing process development and regulatory
services. The cost of our research and development staff is the most significant category of
expense, however we also incur expenses by external service providers, including pre-clinical
studies and consulting expenses. The major expenses relating to our CB001 clinical trial include
external services provided for outside quality control testing, clinical trial monitoring, data
management, and fees relating to the general administration of the clinical trial. Other direct
expenses relating to our CB001 clinical trial include site costs and the cost of the cord blood. We expect that research and development expenses will continue to increase in the foreseeable
future as we add personnel, expand our clinical trial activities and increase our discovery
research and regulatory capabilities. The amount of these increases is difficult to predict due to
the uncertainty inherent in the timing and extent of clinical trial initiations, the progress in
our discovery research programs, the rate of patient enrollment and the detailed design of future
clinical trials. In addition, the results from our clinical trials, as well as the results of
trials of similar therapeutics under development by others, will influence the number, size and
duration of planned and unplanned trials. On an ongoing
basis, we evaluate the results of our product candidate programs, all of which are currently
in early stages. Based on these assessments, for each program, we consider options including, but
not limited to, terminating the program, funding continuing research and development with the
eventual aim of commercializing products, or licensing the program to third parties. Our selling and marketing expenses relate primarily to our ViaCell Reproductive Health
franchise. The majority of these costs relate to our sales force and support personnel, as well as
telecommunications expense related to our call center. We also incur external costs associated with
advertising, direct mail, promotional and other marketing services. We expect that selling and
marketing expenses will increase in the foreseeable future as we expand our sales and marketing
efforts and launch Viacyte. Our general and administrative expenses include our costs related to the finance, legal, human
resources, information technology, business development and corporate governance areas. These costs
consist primarily of expenses related to our staff, as well as external fees paid to our legal and
financial advisers, business consultants and others. We expect that these costs will increase in
future years as we expand our business activities and as we incur additional costs associated with
being a publicly-traded company. During the quarter ended March 31, 2005, we recorded an additional restructuring expense of
$0.1 million due to a refinement of our estimates related to the closing of our German facility. In
March 2005, we were notified that approximately $160,000 in grant proceeds related to fixed asset
expenditures were not reimbursable under the grant and would have to be repaid. We recorded a
reversal of approximately $44,000 in grant revenue and $121,000 in restructuring expense, as that
portion had not been recognized as grant revenue prior to December 31, 2004. We are in the final
stages of finalizing the FY 2004 grant reimbursements and consider it unlikely that any further
adjustment is necessary as of March 31, 2005. 23




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##### Table of Contents



Results of Operations Three Months Ended March 31, 2005 and 2004 (table amounts in thousands, changes based on rounded
amounts in thousands) Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Processing revenues
    
    $
    8,319
    
    
    $
    7,561
    
    
    $
    758
    
    
    
    10
    %Storage revenues
    
    
    1,656
    
    
    
    1,022
    
    
    
    634
    
    
    
    62
    %Total
    
    
    9,975
    
    
    
    8,583
    
    
    
    1,392
    
    
    
    16
    %Grant and contract revenues
    
    
    165.
    
    
    
    436
    
    
    
    (271
    )
    
    
    (62
    %)Total revenues
    
    $
    10,140
    
    
    $
    9,019
    
    
    
    1,121
    
    
    
    12
    %
 The increase in processing and storage revenues of $1.4 million or 16% from 2004 to 2005 was
due primarily to an increase in pricing, as well as an increase in the number of cords stored. The
decrease in grant and contract revenues of $0.3 million or 62% from 2004 to 2005 was primarily due
to the decrease in contract revenue derived from research activities in the United States of $0.1
million and a decrease in grant revenue of $0.3 million from Kourion Therapeutics, our German
subsidiary, which was closed in 2004. These decreases were partially offset by an increase of $0.1
million in grant revenue from the Government of Singapore. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Cost of revenues:Direct costs
    
    $
    1,948
    
    
    $
    1,818
    
    
    $
    130
    
    
    
    7
    %Royalty expense
    
    
    
    
    
    
    526
    
    
    
    (526
    )
    
    
    (100
    %)Total cost of revenues
    
    $
    1,948
    
    
    $
    2,344
    
    
    
    (396
    )
    
    
    (17
    %)
 The increase in direct costs of $0.1 million or 7% from 2004 to 2005 was due primarily to
increased variable expenses of $0.1 million relating to transportation of, materials for
collecting, and testing of the cord blood. The decrease in royalty expense of $0.5 million or 100% was due to the royalty expense no
longer being required in connection with the PharmaStem lawsuit following the judges ruling in
September 2004 that overturned a prior jury verdict, announced in October 2003, based on which we
recorded a royalty expense. On December 14, 2004, the federal district court reversed its
post-trial ruling granting a new trial on the issues of infringement and damages (if any) of the
second patent and overturned the jurys verdict of infringement of that patent. In its September
and December 2004 decisions, the judge found that there was no legally sufficient basis for finding
infringement of either PharmaStem patent. While PharmaStem has filed a Notice of Appeal, we believe
that the lawsuit is without merit and that, in light of the judges ruling, no royalty accrual or
expense is required. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Clinical development
    
    $
    2,545
    
    
    $
    2,064
    
    
    $
    481
    
    
    
    23
    %Pre-clinical programs
    
    
    332
    
    
    
    1,021
    
    
    
    (689
    )
    
    
    (67
    %)
 24




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##### Table of Contents



Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Basic research
    
    
    601
    
    
    
    708
    
    
    
    (107
    )
    
    
    (15
    %)Other R&D
    
    
    98
    
    
    
    193
    
    
    
    (95
    )
    
    
    (49
    %)Total research and development
    
    $
    3,576
    
    
    $
    3,986
    
    
    $
    (410
    )
    
    
    (10
    %)
 Clinical development expense is related primarily to outside services and clinical trial
expenses for CB001, and the increase in 2005 reflected the cost of conducting the Phase I clinical
trials that commenced in late 2003. The decrease in pre-clinical programs was primarily due to the
discontinuation of our muscular dystrophy program in September 2004, and our cardiac repair
program, which was moved from Germany to the US at the end of 2004 following the closure of our
German operations. This resulted in lower ongoing salary and facility related costs. Basic
research expenses are primarily related to activity at our Singapore research center. Other
research and development expense related primarily to our umbilical cord blood processing and
storage business. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Sales & marketing
    
    $
    5,491
    
    
    $
    5,654
    
    
    $
    (163
    )
    
    
    (3
    %)
 In 2004, a decrease in sales and marketing expenses of $0.2 million from 2004 to 2005 was
primarily due to cost savings attributed to the restructuring of our call center. We reduced the
number of call center employees following the implementation of call center automation technology.
This was partially offset by an increase of $0.6 million in marketing program spending to establish
a strong market presence and achieve sales growth. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005General & administrative
    
    $
    2,764
    
    
    $
    3,368
    
    
    $
    (604
    )
    
    
    (18
    %)
 The decrease in general and administrative expenses of $0.6 million or 18% from 2004 to 2005
primarily due to the following:  
    $0.5 million decrease due to employee related costs as a result of our restructuring in September 2004;
    $0.2 million decrease due to consulting costs related to our ViaCyte program; and
    $0.1 million decrease due to all legal related expenses including PharmaStem litigation,
legal patent and general legal matters; These decreases were partially offset by:  
    a $0.2 million reduction in bad debt expense during the three months ended March 31,
2004 that did not recur during the three months ended March 31, 2005; and
    a $0.1 increase in insurance costs due to higher premiums associated with being a public
company. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Stock-based compensation
    
    $
    436
    
    
    $
    864
    
    
    $
    (428
    )
    
    
    (50
    %)
 25




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##### Table of Contents



Stock-based compensation expense represents the amortization of the excess of the fair value
on the date of the grant of the stock underlying the options granted to employees, over the
exercise price. The amortization is based on the vesting period of the related options. The amount
of stock-based compensation actually recognized in future periods could decrease if options for
which accrued but unvested compensation has been recorded are forfeited. For the three months
ended March 31, 2005, we did not grant any options with exercise prices less than the fair market
value. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Restructuring
    
    $
    121
    
    
    
    
    
    
    $
    121
    
    
    
    100
    %
 The $0.1 million charge in 2005 is due to revised restructuring estimates related to the
closing of our German facility. We are in the final stages of finalizing the fiscal 2004 grant
reimbursements with the German government and consider it unlikely that any further adjustment is
necessary as of March 31, 2005. Three Months Ended March 31,$ Change
    
    
    % Change2005
    
    
    2004
    
    
    2004 to 2005
    
    
    2004 to 2005Interest income
    
    $
    315
    
    
    
    146
    
    
    
    169
    
    
    
    116
    %Interest expense
    
    
    (155
    )
    
    
    (394
    )
    
    
    239
    
    
    
    61
    %Total interest income (expense), net
    
    $
    160
    
    
    $
    (248
    )
    
    $
    408
    
    
    
    165
    %
 Interest income is earned from the investment of our cash in short and long term securities
and money market funds. The increase in interest income primarily relates to increased average
investment balances resulting from a higher cash balance available for investment following our
initial public offering in January, 2005. The decrease in interest expense relates to the
reduction of interest on the related party note, which was paid in full at the closing of our IPO
in January 2005. Liquidity and Capital Resources From inception through March 31, 2005, we have raised $191.1 million in common and preferred
stock issuances, which includes $53.3 million in net proceeds from our initial public offering in
January 2005. We used approximately $15.5 million of these net proceeds to repay in full the
related party note, including accrued interest. As of March 31, 2005, we had approximately $67.5
million in cash, cash equivalents and investments, which we believe is sufficient to meet our
anticipated liquidity needs for at least the next three years. Three Months Ended March 31,$ Change2005
    
    
    2004
    
    
    2004 to 2005Net cash provided by (used in) operating activities
    
    $
    2,052
    
    
    $
    (7,585
    )
    
    $
    9,637Net cash used in investing activities
    
    
    (6,137
    )
    
    
    (20,004
    )
    
    
    13,867Net cash provided by (used in) financing activities
    
    
    37,972
    
    
    
    (898
    )
    
    
    38,870Cash & cash equivalents, end of period
    
    $
    40,528
    
    
    $
    10,400
    
    
    $
    30,128
 Net cash provided by operating activities was $2.0 million for the three months ended March
31, 2005, an increase of $9.6 million over the three months ended March 31, 2004. For the three
months ended March 31, 2005, the $1.6 million in cash provided by operations was due to our net
loss of $4.0 26




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##### Table of Contents



million offset by an increase in working capital of $1.4 million, increase in non-cash
expenses of $1.1 million, and an increase in deferred revenue related to increases in long-term
pre-paid storage contracts and volumes of cords stored and deferred rent of $3.5 million. Net cash used in investing activities for three months ended March 31, 2005 was $6.1 million
as compared to $20.0 for the three months ended March 31, 2004. For the three months ended March
31, 2005, $4.5 million of US Government and high-rated corporate securities matured and $9.6
million was invested in similar securities. For the three months ended March 31, 2004, $2.6 million
of US Government and high-rated corporate securities matured and $22.2 million was invested in
similar securities. We also invested approximately $1.0 million and $0.3 million in fixed assets
for the three months ended March 31, 2005 and 2004 respectively. We expect to incur approximately
$2.5 million in capital expenditures during 2005 in order to complete the build out of our
laboratory in Cambridge, of which approximately $2.5 million is reimbursable by our landlord under
the lease agreement. This facility, when completed, will allow us the capacity to complete Phase II
and Phase III clinical trials and proceed to initial commercialization of CB001, if successfully
developed; however, we will need to build or acquire a manufacturing facility in order to fully
commercialize CB001 and our other product candidates. The timing and cost of such a facility is not
known at this time, however the cost is likely to be substantial. For the three months ended March
31, 2005, other assets decreased by $0.4 million, which relates to a portion of the GE Deposit
becoming current. Net cash provided by financing activities for the three months ended March 31, 2005 was $38
million. Net cash used in financing activities amounted to $0.9 million for the three months ended
March 31, 2004, For the three months ended March 31, 2005, the net cash provided by financing
activities included net proceeds from our IPO of $53.3 million and proceeds of $0.6 million
relating to stock options exercised. These proceeds were partially reduced by cash used to repay a
related part note related to the acquisition of Kourion Therapeutics of $15.5 million and repayment
of $0.4 million relating to our credit facility with General Electric Capital Corporation. We anticipate that our current cash, cash equivalents and investments will be sufficient to
fund our operations for at least the next three years. However, our forecast for the period of time
during which our financial resources will be adequate to support our operations is a
forward-looking statement that involves risks and uncertainties, and actual results could vary
materially. If we are unable to raise additional capital when required or on acceptable terms, we
may have to significantly delay, scale back or discontinue one or more clinical trials, or other
aspects of our operations. Off-Balance Sheet Transactions We did not have any off balance sheet obligations as of March 31, 2005. Other Arrangements In January 2005, we entered into development and supply agreements with Miltenyi Biotec GmbH.
The development agreement provides for the development by Miltenyi of a cGMP cell separation kit
(the Product) for us consisting of various antibodies conjugated with magnetic particles to be
used in our Selective Amplification process for the development and commercialization of our
therapeutic cellular therapy products based on the Selective Amplification technology. Under the
development agreement, Miltenyi is obligated to perform various tasks set forth in the agreement in
connection with the development of the Product, including making various filings with the FDA. We
are obligated to pay up to $950,000. As of March 31, 2005, we had paid $700,000 relating to this
development program, and will recognize the payments ratably over the expected development period.
The remaining $250,000 is a milestone to be paid upon filing with the FDA. The term of the
agreement ends on the earlier of the expiration of both parties obligations under the development
agreement and January 24, 2007. 27




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##### Table of Contents



The supply agreement provides for the exclusive supply of the Product by Miltenyi to us. The
initial term of the supply agreement is for seven years. We have guaranteed minimum purchase
requirements totaling at least $1.6 million within the first year after the process development
program has been completed. Also, we have certain minimum annual purchase requirements starting in
fiscal 2007 which will apply if CB001 continues in clinical trials or is commercialized. We are a party to various agreements including license, research collaboration, consulting and
employment agreements and may enter into additional agreements in the future. We may require
additional funds for conducting clinical trials and for preclinical research and development
activities relating to our product candidates, as well as for the expansion of our cord blood
preservation facility, construction of a cellular therapy manufacturing facility, acquisitions of
technologies or businesses, the establishment of partnerships and collaborations complementary to
our business and the expansion of our sales and marketing activities. Legal Proceedings We were sued by PharmaStem Therapeutics, Inc. for allegedly infringing two patents relating to
our Viacord umbilical cord stem cell cryopreservation business after we rejected PharmaStems
initial requests seeking a license arrangement because we believe that we do not infringe these
patents and that they are invalid. PharmaStem filed a complaint in early 2002 against us and
several other defendants in the United States District Court for the District of Delaware, alleging
infringement of US Patents No. 5,004,681 and No. 5,192,553, relating to certain aspects of the
collection, cryopreservation and storage of hematopoietic stem cells and progenitor cells from
umbilical cord blood. In 2003, the jury ruled against us and the other defendants, Cbr Systems,
CorCell and Cryo-Cell, who represent a majority of the family cord blood preservation industry, and
a judgment was entered against us for approximately $2.9 million, based on 6.125% royalties on our
revenue from the processing and storage of umbilical cord blood since April 2000. In 2004, the Delaware Court overturned the judgment against ViaCell on the 553 method patent,
ruling that we did not infringe the patent. Regarding the 681 composition patent, the Court
initially vacated the verdict and ordered a new trial on infringement and damages (if any), in
connection with which, PharmaStem sought a preliminary injunction. However, the Court subsequently
reversed its ruling, overturning the jurys verdict of infringement of the 681 patent and denying
PharmaStems motion for preliminary injunction. On January 6, 2005, PharmaStem filed a Notice of
Appeal and a Motion to Expedite the Appeal of the Courts decision. On February 15, 2005, that
Motion to Expedite the Appeal was denied. PharmaStems appeal brief was filed on March 22, 2005,
and our appeal brief is due May 16, 2005. In August 2004, the US Patent and Trademark Office (US PTO) ordered the re-examination of both
the 553 method patent and the 681 composition patent based on the prior art. On February 2, 2005,
the PTO issued an Office Action rejecting all claims of the 553 patent as invalid over prior art. Should the US PTO find the claims of these patents to be unpatentable, then the litigation
proceedings between us and PharmaStem with respect to the unpatentable claims would cease. If the
Courts judgment as to non-infringement of the 553 or 681 patent is reversed on appeal and if we
are subsequently enjoined from further engaging in our umbilical cord stem cell cryopreservation
business, we will not be able to conduct this business unless PharmaStem grants a license to us,
which PharmaStem previously informed us that it would not do after October 15, 2004. While we do
not believe this outcome is likely, if, in the event of an injunction, we are not able to obtain a
license under the disputed patents or operate under an equitable doctrine known as intervening
rights, we will be required to stop preserving and storing cord blood and to cease using
cryopreserved umbilical cord blood as a source for stem cell products. 28




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##### Table of Contents



PharmaStem also filed a complaint against us in July 2004 in the United States District Court
for the District of Massachusetts, alleging infringement of US Patents No. 6,461,645 and 6,569,427,
which also relate to certain aspects of the collection, cryopreservation and storage of
hematopoietic stem cells and progenitor cells from umbilical cord blood. By agreement of the
parties, ViaCell responded to the complaint on December 16, 2004. We continue to believe that the
patents in this new Massachusetts action are invalid and that we do not infringe them in any event.
On January 7, 2005, PharmaStem filed a Motion for Preliminary Injunction in the Massachusetts
litigation. That Motion is currently stayed. If this Motion is granted, we could be enjoined from
collecting and storing cord blood that had not been collected as of the date the injunction is
issued while the case is litigated and thereafter if we lose the case. We believe that the issues
presented in PharmaStems Motion are substantially the same as the issues presented in the Delaware
litigation and, while no assurance can be given, we believe that PharmaStems Motion will be
denied. If we are ultimately found to infringe, we could have a significant damages award entered
against us, and we could also face an injunction which could prohibit us from further engaging in
the umbilical cord stem cell business absent a license from PharmaStem on the disputed patents. We
believe the issues presented in this case are substantially the same as the issues presented in the
Delaware litigation. Accordingly, we filed a motion to consolidate the Massachusetts case with six
other actions against other defendants in a single proceeding in the District of Delaware. On
January 21, 2005, the Massachusetts case was stayed pending a ruling on this request. On February
16, 2005, our request was granted. The cases have thus been consolidated in Delaware. In April 2005, the US PTO ordered re-examination of some claims of the patents at issue in the
second litigation, the 645 and 427 patents, based on the prior art. A request for re-examination
of other claims of those patents was denied. The timing and order of the litigations involving ViaCell and PharmaStem are not presently
known. Decisions in the re-examination proceedings of the 681, 553, 645 and 427 patents, now
pending before the US PTO, may also affect these factors. We may enter into settlement negotiations with PharmaStem regarding our litigation with
PharmaStem. We cannot predict whether any such negotiations would lead to a settlement of these
lawsuits or what the terms or timing of any such settlement might be, if it occurs at all. On May 13, 2004, we received a First Amended Complaint filed in the Superior Court of the
State of California by Kenneth D. Worth, by and for the People of the State of California, and
naming as defendants a number of private cord blood banks, including us. The complaint alleges that
the defendants have made fraudulent claims in connection with the marketing of their cord blood
banking services and seeks restitution for those affected by such marketing, injunctive relief
precluding the defendants from continuing to abusively and fraudulently market their services and
requiring them to provide certain information and refunds to their customers, unspecified punitive
and exemplary damages and attorneys fees and costs. Subsequently, we received a Notice of Ex Parte
Application for Leave to Intervene filed on behalf of the Cord Blood Foundation by the same
individual and seeking similar relief. On October 7, 2004, the Court orally granted a motion to
strike the complaint under the California anti-SLAPP statute and dismissed the complaint as to all
defendants without leave to amend. Judgment has been entered, dismissing the complaint, and
plaintiff has filed a notice of appeal and a petition for a writ of mandate. The petition has been
dismissed and the appeal is proceeding. We believe that the plaintiff is in the process of
negotiating a settlement with all defendants other than us. We are not yet able to conclude as to
the likelihood that plaintiffs claims would be upheld if the judgment of dismissal were reversed
on appeal, nor can we estimate the possible financial consequences should plaintiff prevail.
However, we believe this suit to be without merit and intend to continue to vigorously defend
ourselves. On February 24, 2005, Cbr Systems, Inc., a private cord blood banking company, filed a
complaint against us in the United States District Court for the Northern District of California
alleging 29




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##### Table of Contents



false and misleading advertising by us in violation of the federal Lanham Act and various
California statutes and common law and seeking an injunction from continuing such advertising and
unspecified damages. On April 13, 2005, we answered the complaint, denying Cbrs allegations, and
filed counterclaims alleging false and misleading advertising by Cbr. Our counterclaims seek an
injunction and damages, and we intend to vigorously defend ourselves in this action. Critical Accounting Estimates The Companys critical accounting estimates are disclosed in the section Managements
Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting
Estimates of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004. Risk Factors that May Affect Results Our cellular therapy product candidates are at an early stage of development, and if we are
not able to successfully develop and commercialize them, we may not generate sufficient
revenues to continue our business operations. Our cellular therapy product candidates are in the early stages of development. In particular,
our lead stem cell product candidate, CB001, has only recently entered Phase I clinical trials.
CB001 has not previously been studied in humans, and we have very limited safety and no efficacy
data on this product candidate yet. While stem cell therapy is an accepted medical procedure for
the regeneration of the blood and immune systems for patients with cancer and other serious
diseases  a procedure for which we are developing CB001  stem cell populations expanded using our
Selective Amplification technology have not yet been shown to be safe or effective for such
treatments. Additionally, there has been only limited use of stem cells in treating cardiac disease
in clinical trial settings, which is an additional indication we are targeting. As a result, there
is substantial uncertainty about the effectiveness of CB001 for its target indication and about
whether our program targeting another indication will be successful. We expect that none of our cellular therapy product candidates will be commercially available
for at least three years, if at all. We will need to devote significant additional research and
development, financial resources and personnel to develop commercially viable products and obtain
regulatory approvals. We may discover that manipulation of stem cells using Selective Amplification changes the
biological characteristics of stem cells. For this or other reasons, therapeutic products developed
with our stem cell expansion technology may fail to work as intended, even in areas where stem cell
therapy is already in use. This may result from the failure of our products to:  
    properly engraft into the recipients body in the desired manner;
    provide the intended therapeutic benefits; or
    achieve benefits that are better or equal to existing therapies. While our Selective Amplification technology has shown successful results in preclinical
research, those results were not obtained in humans and may not be indicative of results we may
encounter in future preclinical studies or clinical trials. Since none of our product candidates
have progressed past Phase I clinical trials, we cannot determine whether our preclinical testing
methodologies are predictive of clinical safety or efficacy. As we obtain results from further
preclinical or clinical trials, we may elect to discontinue or delay preclinical studies or
clinical trials for certain product candidates in order to focus our resources on more promising
product candidates. We may also change the indication being pursued for a particular product
candidate or otherwise revise the development plan for that candidate. Moreover, product candidates
in later stages of clinical trials may fail to show the desired safety and efficacy traits despite
having progressed through preclinical or initial clinical testing. 30




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If our product candidates do not prove to be safe and efficacious in clinical trials, we will
not obtain the required regulatory approvals for our technologies or product candidates. Even if we
are successful in developing and gaining regulatory approval for CB001, we do not expect to obtain
approval before 2008. We may not be able to sustain our current level of revenues or our recent growth rates. Revenues from our umbilical cord blood preservation and storage products have grown
significantly over the past several years, from $7.1 million in fiscal 2001, to $20.1 million in
fiscal 2002, to $30.9 million in fiscal 2003 and to $36.8 million in fiscal 2004. We believe that
this is a result of our increased marketing efforts and from increased awareness by the public
generally of the concept of cord blood banking. We may not be able in the future, however, to
sustain this growth rate nor the current level of Viacords revenues. Principal factors that may
adversely affect our revenue, such as litigation, competition from other private cord blood banks
or risks of reputational damage, are described in more detail elsewhere in this Risk Factors That
May Affect Results section. If we are unable to sustain our revenues, we may need to reduce our
product candidate development activities or raise additional funds earlier than anticipated or on
unfavorable terms. We expect to continue to incur operating losses and may never become profitable. We have generated operating losses since our inception. As of March 31, 2005, we had
cumulative net losses of approximately $162.8 million. These losses have resulted principally from
the costs of our research and development activities, which have totaled approximately $91.9
million since our inception. We expect our losses to continue for the next several years as we make
substantial expenditures to further develop and commercialize our product candidates. In
particular, we expect that our rate of spending will accelerate over the next several years as a
result of increased costs and expenses associated with clinical trials, including our current Phase
I trial for CB001, submissions for regulatory approvals and potential commercialization of our
products, including the build out of commercial scale manufacturing facilities. Furthermore, we
expect to make additional investments in the near term in our ViaCell Reproductive Health
franchise, as we seek to expand the market for our Viacord product offering and develop our Viacyte
product candidate. Our ability to become profitable will depend on many factors, including our
ability to establish the safety and efficacy of our product candidates, obtain necessary regulatory
approvals and successfully commercialize products. We cannot assure you that we will ever become
profitable. We and several other defendants, representing a majority of the industry, are defendants in
lawsuits alleging infringement of patents relating to our Viacord umbilical cord stem cell
cryopreservation business. If we are not able to resolve the suits favorably, we could be
permanently enjoined from further engaging in this business, which would result in the loss of the
current source of almost all of our revenues, or we may be required to pay a royalty. We were sued for allegedly infringing two patents relating to our Viacord umbilical cord stem
cell cryopreservation business after we rejected the initial requests of the plaintiff, PharmaStem
Therapeutics, Inc., seeking a license arrangement because we believe that we do not infringe these
patents and that they are invalid. In October 2003, the jury in this case in the United States
District Court for the District of Delaware ruled that we and the several other defendants, who
represent a majority of the family cord blood preservation industry, willfully infringed the two
patents, which relate to certain aspects of the collection, cryopreservation and storage of
hematopoietic stem cells and progenitor cells from umbilical cord blood. In 2004, the federal
district court overturned the jury verdict against ViaCell on one of the two patents, ruling that
we did not infringe the patent. Regarding the other patent, the Court initially vacated the
verdict and granted a new trial on infringement and damages (if any) in connection with which
PharmaStem sought a preliminary injunction. However, the Court subsequently 31




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reversed its ruling, overturning the jurys verdict of infringement of the patent and denying
PharmaStems motion for preliminary injunction. On January 6, 2005, PharmaStem filed a Notice of
Appeal and on March 22, 2005 filed its appeal brief. Our appeal brief is due May 16, 2005. In August 2004, the US Patent and Trademark Office (US PTO) ordered the re-examination of
both of these patents based on the prior art submitted. On February 2, 2005, the PTO issued an
Office Action rejecting all claims of the 553 method patent as unpatentable over the prior art.
PharmaStem will now have an opportunity to respond to this Office Action by arguing that its claims
are patentable. If the US PTO does not find the claims of the patents to be unpatentable and if an
appeal in the litigation is not resolved favorably to us, we could be enjoined from further
engaging in our umbilical cord stem cell cryopreservation business. In such case, we will not be
able to conduct this business unless PharmaStem grants a license to us. In such event, PharmaStem
would be under no legal obligation to grant us a license or to do so on economically reasonable
terms, and previously informed us that it would not do so at all after October 15, 2004. If it
becomes necessary, but we are unable, to obtain a license, or are unable to obtain a license on
economically reasonable terms, we will not be able to further engage in our umbilical cord stem
cell cryopreservation business. If we cannot continue our cord blood preservation business, that
would have a material adverse effect on our business, results of operations and financial
condition, as we would no longer have access to the current source of almost all of our revenues.
We had revenues of approximately $36.8 million in 2004 from Viacord sales. The judgment in the
case, which was subsequently overturned, was entered against us for approximately $2.9 million
relating to past infringement, based on 6.125% royalties on our revenue from the storage of
umbilical cord blood since April 2000. If it becomes necessary, and we are able, to obtain a
license from PharmaStem, it may be at a royalty rate greater than 6.125% or on terms less favorable
than PharmaStem has granted to other cord blood banks. For example, we understand PharmaStem has
licensed other cord blood banks under its patents for royalty rates of 15%. We have also been sued
again by PharmaStem in federal district court in Massachusetts on two different but related
patents, as have several others in the family cord blood preservation industry, albeit in separate
actions in other courts, and many of the same risks are present in that litigation as in the
original Delaware litigation. We filed  and were subsequently granted  a motion to consolidate
the Massachusetts case with six other actions in a single proceeding in the District of Delaware.
On January 7, 2005, PharmaStem filed a Motion for Preliminary Injunction in the Massachusetts
litigation. If this Motion is granted, we could be enjoined from collecting and storing cord blood
that had not been collected as of the date the injunction is issued while the case is litigated and
thereafter if we lose the case. We believe that the issues presented in PharmaStems Motion are
substantially the same as the issues presented in the Delaware litigation and, while no assurance
can be given, we believe that PharmaStems Motion will be denied. We may enter into settlement
negotiations with PharmaStem regarding our litigation with PharmaStem. We cannot predict whether
any such negotiations would lead to a settlement of these lawsuits or what the terms or timing of
any such settlement might be, if it occurs at all. For a fuller discussion of the PharmaStem
litigation, see the section entitled Part II, Item I  Legal Proceedings of this report. We may not be able to raise additional funds necessary to fund our operations. As of March 31, 2005, we had approximately $67.5 million in cash, cash equivalents, short- and
long-term investments. In order to develop and bring our stem cell product candidates to market, we
must commit substantial resources to costly and time-consuming research, preclinical testing and
clinical trials. While we anticipate that our existing cash, cash equivalents and investments will
be sufficient to fund our current operations for the three years, we may need or want to raise
additional funding sooner, particularly if our business or operations change in a manner that
consume available resources more rapidly than we anticipate. We expect to attempt to raise
additional funds well in advance of completely depleting our available funds. Our future capital requirements will depend on many factors, including: 32




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
    the level of cash flows from our umbilical cord blood preservation activities;
    the scope and results of our research and development programs;
    the scope and results of our clinical trials, particularly those involving
CB001, which is currently in a Phase I trial;
    the timing of and the costs involved in obtaining regulatory approvals, which
could be more lengthy or complex than obtaining approval for a new conventional drug,
given the FDAs relatively little experience with cellular-based therapeutics;
    the costs of building and operating our manufacturing facilities, both in the
near term to support our clinical activities, and also in anticipation of growing our
commercialization activities;
    funds spent in connection with acquisitions of related technologies or
businesses, including contingent payments that may be made in connection with our
acquisition of Kourion Therapeutics;
    the costs of maintaining, expanding and protecting our intellectual property
portfolio, including litigation costs and liabilities; and
    our ability to establish and maintain collaborative arrangements and obtain
milestones, royalties and other payments from collaborators. We may seek additional funding through collaborative arrangements and public or private
financings. Additional funding may not be available to us on acceptable terms, or at all. If we
obtain additional capital through collaborative arrangements, these arrangements may require us to
relinquish greater rights to our technologies or product candidates than we might otherwise have
done. If we raise additional capital through the sale of equity, or securities convertible into
equity, further dilution to our then existing stockholders will result. If we raise additional
capital through the incurrence of debt, our business may be affected by the amount of leverage we
incur. For instance, such borrowings could subject us to covenants restricting our business
activities, servicing interest would divert funds that would otherwise be available to support
research and development, clinical or commercialization activities, and holders of debt instruments
would have rights and privileges senior to those of our equity investors. If we are unable to
obtain adequate financing on a timely basis, we may be required to delay, reduce the scope of or
eliminate one or more of our programs, any of which could have a material adverse effect on our
business. If the potential of stem cell therapy to treat serious diseases is not realized, the value
of our Selective Amplification technology and our development programs could be
significantly reduced. The potential of stem cell therapy to treat serious diseases is currently being explored by us
and other companies. It has not been proven in clinical trials that stem cell therapy will be an
effective treatment for diseases other than those currently addressed by hematopoietic stem cell
transplants. No stem cell products have been successfully developed and commercialized to date, and
none has received regulatory approval in the United States or internationally. Stem cell therapy
may be susceptible to various risks, including undesirable and unintended side effects, unintended
immune system responses, inadequate therapeutic efficacy or other characteristics that may prevent
or limit their approval or commercial use. If the potential of stem cell therapy to treat serious
diseases is not realized, the value of our Selective Amplification technology and our development
programs could be significantly reduced. 33




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We cannot market and sell CB001 or our other product candidates in the United States or in
other countries if we fail to obtain the necessary regulatory approvals or licensure. We cannot sell CB001, or other cellular product candidates, until regulatory agencies grant
marketing approval, or licensure. The process of obtaining regulatory approval is lengthy,
expensive and uncertain. It is likely to take three to five years or more to obtain the required
regulatory approvals for our lead stem cell product candidate, CB001, or we may never gain
necessary approvals. Any difficulties that we encounter in obtaining regulatory approval may have a
substantial adverse impact on our operations and cause our stock price to decline significantly. To obtain regulatory approvals in the United States for CB001, for instance, we must, among
other requirements, complete carefully controlled and well-designed clinical trials sufficient to
demonstrate to the US Food & Drug Administration, or FDA, that CB001 is safe, effective and potent
for each disease for which we seek approval. Several factors could prevent completion or cause
significant delay of these trials, including an inability to enroll the required number of patients
or failure to demonstrate adequately that CB001 is safe, effective and potent for use in humans.
Although we currently anticipate that we may complete patient enrollment in our Phase l clinical
trial for CB001 by the third quarter of 2005, the completion of patient enrollment for the Phase 1
trial may take longer than anticipated. Negative or inconclusive results from or adverse medical
events during a clinical trial could cause the clinical trial to be repeated or a program to be
terminated, even if other studies or trials relating to the program are successful. The FDA can
place a clinical trial on hold if, among other reasons, it finds that patients enrolled in the
trial are or would be exposed to an unreasonable and significant risk of illness or injury. If
safety concerns develop, we or the FDA could stop our trials before completion. Although we do not
have particular reasons to expect unusual delays or a need to terminate our clinical trials, to
date, some participants in our CB001 clinical trial have experienced serious adverse events, two of
which have been determined to be possibly related to CB001. A serious adverse event is an event
that results in significant medical consequences, such as hospitalization, disability or death and
must be reported to the FDA. While we believe that the serious adverse event profiles we have
observed are consistent with those of the disease conditions of patients in the trial and with
those associated with stem cell and bone marrow transplants generally, we cannot assure you that
safety concerns regarding CB001 will not develop. We have only recently initiated our first clinical trial for CB001, and thus have no clinical
trial history for this product candidate. Indeed, the FDA has relatively little experience with
therapeutics based on cellular medicine generally. As a result, the pathway to regulatory approval
for CB001 may be more complex and lengthy than for approval of a new conventional drug. Similarly,
to obtain approval to market our stem cell products outside of the United States, we will need to
submit clinical data concerning our products and receive regulatory approval from governmental
agencies, which in certain countries includes approval of the price we intend to charge for our
product. We may encounter delays or rejections if changes occur in regulatory agency policies
during the period in which we develop a product candidate or during the period required for review
of any application for regulatory agency approval. If we are not able to obtain regulatory
approvals for use of CB001 or other products under development, we will not be able to
commercialize such products, and therefore may not be able to generate sufficient revenues to
support our business. Our cell preservation activities are subject to regulations that may impose significant
costs and restrictions on us. Cord blood preservation. Our Viacord cord blood preservation product is currently subject to
FDA regulations requiring infectious disease testing. We have registered with the FDA as a cord
blood preservation service, listed our products with the FDA, and we are subject to FDA inspection.
In addition, the FDA has recently adopted new good tissue practice (GTP) regulations that establish
a comprehensive regulatory program for human cellular and tissue-based products and finalized rules
for 34




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donor eligibility and that will become effective in May of 2005. We believe that we comply with
existing regulatory requirements and will be in compliance with the new GTP regulations as recently
adopted. However, we may not be able to maintain this compliance or comply with future regulatory
requirements that may be imposed on us, including product standards that may be developed.
Moreover, the cost of compliance with government regulations may adversely affect our revenue and
profitability. Regulation of our cord blood preservation services in foreign jurisdictions is still
evolving. Consistent with industry practice, the Viacord cord blood collection kits have not been
cleared as a medical device. The FDA could at any time require us to obtain medical device
premarket application (PMA) approval or 510(k) clearance for the collection kits, or new drug
application supplement (sNDA) approval for a drug component of the kits. Securing any necessary
medical device 510(k) clearance or PMA approval for the cord blood collection kits, or sNDA
approval for a drug component of the kits, may involve the submission of a substantial volume of
data and may require a lengthy substantive review. The FDA also could require that we cease
distributing the collection kits and require us to obtain medical device 510(k) clearance or PMA
approval for the kits or sNDA approval of a drug component of the kits prior to further
distribution of the kits. Of the states in which we provide cord blood banking services, only New Jersey, New York,
Maryland, Kentucky, Illinois and Pennsylvania currently require that cord blood banks be licensed
or registered. We are currently licensed or registered to operate in New Jersey, New York,
Kentucky, Illinois and Pennsylvania, and we believe that we will be able to comply with the license
and registration requirements in Maryland which we recently identified. If other states adopt
requirements for the licensing or registration of cord blood preservation services, we would have
to obtain licenses or register to continue providing services in those states. Oocyte cryopreservation. There are no established precedents for US and international
regulation of oocyte cryopreservation. We anticipate that in the Unites States cryopreservation of
oocytes will be regulated similarly to Viacords family umbilical cord blood cryopreservation
product. We also anticipate that some of the components used in this product will be regulated as
medical devices under a 510(k) clearance mechanism. For instance, prior to marketing this product,
our media supplier will be required to obtain 510(k) clearance for the technology we have licensed
for use in the cryopreservation of oocytes. In November of 2004, our media supplier submitted a
510(k) to the FDA for clearance of the oocyte cryopreservation media. In January of 2005, our media
supplier informed us that they had received a letter from the FDA that included the following
information:  
    a statement that our media supplier will need to conduct a clinical study that
produces pregnancy and birth rates data to support the application; and
    a request that various additional information be submitted, including
stability, toxicity testing, biocompatibility and labeling information. Clinical data were not included in the original 510(k) application. Our media supplier
responded to the FDA letter and submitted existing, published third party clinical data and
additional information to the 510(k) application. In April of 2005 our media supplier informed us that they had received a letter from the FDA that
included the following information:  
    a statement that our media supplier had not demonstrated substantial
equivalence of the media to a predicate device and therefore the FDA did not clear the
media for commercial use.
    a statement that our media supplier could resubmit a 510(k) when additional
data supporting substantial equivalence of the media to a predicate device are
available. The Company 35




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believes data from a new clinical trial would support substantial equivalence and a new
510(k) application.
    a statement that the media had been reclassified as a class 3 device and that
in order to commercially market the device in the U.S. an approved PMA would be
required, unless the device was reclassified, in which case the media could be cleared
for marketing based on a 510(k). The Company believes the media will be reclassified
as a class 2 device at the time of resubmission of a 510(k) which includes data from a
new clinical trial.
    a statement that any clinical investigation performed using the media in the
U.S. would require an investigation device exemption (IDE). We believe data from a new clinical trial would support substantial equivalence and a new
510(k) application. We also believe the oocyte cryopreservation media will be re-classified as a
class 2 device at the time of re-submission of a 510(k) filing which would include data from a new
clinical trial, although there can be no assurance that the FDA will not require a PMA filing
rather than a 510(k) filing. In addition, no assurance can be given that the media will be
approved by the FDA even following submission of a new filing with clinical trial data. A failure
to re-classify the media as a class 2 device would substantially lengthen our planned developmental
timeline for and substantially increase the costs of commercializing this service. We have not
investigated the regulations for the cryopreservation of oocytes in foreign jurisdictions. We depend on patents and other proprietary rights that may fail to protect our business. Our success depends, in large part, on our ability to obtain and maintain intellectual
property protection for our product candidates, technologies and trade secrets. We own or have
exclusive licenses to six US patents and two international patents. We also own or have exclusive
licenses to 12 pending applications in the United States and 52 pending applications in foreign
countries. Our pending patent applications may not issue, and we may not receive any additional
patents. The patent position of biotechnology companies is generally highly uncertain, involves
complex legal and factual questions and has recently been the subject of much litigation. Neither
the US Patent and Trademark Office nor the courts have a consistent policy regarding the breadth of
claims allowed or the degree of protection afforded under many biotechnology patents. The claims of
our existing US patents and those that may issue in the future, or those licensed to us, may not
offer significant protection of our Selective Amplification and other technologies. Our patents on
Selective Amplification, in particular, are quite broad in that they cover selection and
amplification of any targeted cell population. While Selective Amplification is covered by issued
patents and we are not aware of any challenges, patents with broad claims tend to be more
vulnerable to challenge by other parties than patents with more narrowly written claims. Our patent
applications covering Unrestricted Somatic Stem Cells (USSCs) claim these cells as well as their
use in the treatment of many diseases. It is possible that these cells could be covered by other
patents or patent applications which identify, isolate or use the same cells by other markers,
although we are not aware of any. Third parties may challenge, narrow, invalidate or circumvent any
patents we obtain based on these applications. Furthermore, our competitors may independently develop similar technologies or duplicate any
technology developed by us in a manner that does not infringe our patents or other intellectual
property. Because of the extensive time required for development, testing and regulatory review of
a potential product, it is possible that, before any of our products can be commercialized, any
related patent may expire or remain in force for only a short period following commercialization,
thereby reducing any advantages of the patent. For instance, our patents on Selective Amplification
issued in 1997 and will expire in 2014. To the extent our product candidates based on that
technology are not commercialized significantly ahead of this date, or to the extent we have no
other patent protection on such products, 36




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those products would not be protected by patents beyond 2014. Without patent protection, those
products might have to compete with identical products by competitors. In an effort to protect our unpatented proprietary technology, processes and know-how as trade
secrets, we require our employees, consultants, collaborators and advisors to execute
confidentiality agreements. These agreements, however, may not provide us with adequate protection
against improper use or disclosure of confidential information. These agreements may be breached,
and we may not have adequate remedies for any such breach. In addition, in some situations, these
agreements may conflict with, or be subject to, the rights of third parties with whom our
employees, consultants, collaborators or advisors have previous employment or consulting
relationships. Also, others may independently develop substantially equivalent proprietary
information and techniques or otherwise gain access to our trade secrets. CB001 and our other cellular product candidates represent new forms of therapy or products
that the marketplace may not accept. Even if we successfully develop and obtain regulatory approval for CB001 or other stem cell
therapy products, the market may not accept them. Other than hematopoietic stem cell transplants,
stem cell therapy is not currently a commonly used procedure. Similarly, our oocyte
cryopreservation product candidate, if developed and cleared for commercial use, may not be
accepted by the market. Market demand for our products will depend primarily on acceptance by
patients, physicians, medical centers and third party payers. Commercial acceptance will be
dependent upon several factors, including:  
    the number and relative efficacy of products that compete with our product;
    our ability to supply a sufficient amount of our product to meet demand;
    our ability to build and maintain, or access through third parties, a capable sales
force;
    our ability to successfully fund launch costs; and
    our ability to obtain insurance coverage and reimbursement for our cellular therapy
products. Our success will depend in part on establishing and maintaining effective strategic
partnerships and collaborations. A key aspect of our business strategy is to establish strategic relationships in order to gain
access to technology and critical raw materials, to expand or complement our research, development
or commercialization capabilities, or to reduce the cost of developing or commercializing products
on our own. We currently have strategic relationships with Amgen, Genzyme and Massachusetts General
Hospital. While we are currently in discussions with a number of companies, universities, research
institutions, public cord blood banks and others to establish additional relationships and
collaborations, we may not reach definitive agreements with any of them. Even if we enter into
these arrangements, we may not be able to maintain these relationships or establish new ones in the
future on acceptable terms. Furthermore, these arrangements may require us to grant certain rights
to third parties, including exclusive marketing rights to one or more products, or may have other
terms that are burdensome to us, and may involve the acquisition of our securities. Our partners
may decide to develop alternative technologies either on their own or in collaboration with others.
If any of our partners terminate their relationship with us or fail to perform their obligations in
a timely manner, the development or commercialization of our technology and potential products may
be substantially delayed. 37




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Third parties may own or control patents or patent applications that are infringed by our
technologies or product candidates. Our success depends in part on our not infringing other parties patents and proprietary
rights as well as not breaching any licenses relating to our technologies and product candidates.
In the United States, patent applications filed in recent years are confidential for 18 months,
while older applications are not published until the patent issues. As a result, there may be
patents of which we are unaware, and avoiding patent infringement may be difficult. We may
inadvertently infringe third party patents or patent applications. These third parties could bring
claims against us, our collaborators or our licensors that, even if resolved in our favor, could
cause us to incur substantial expenses and, if resolved against us, could additionally cause us to
pay substantial damages. For instance, in defending the Delaware claim of patent infringement
brought against us by PharmaStem, which, until recently, was the only infringement claim we had
faced, we have incurred total legal expenses as of March 31, 2005 of $6.7 million. Depending upon
the extent of the appeals process concerning either or both patents asserted in Delaware, and the
extent we litigate the additional patent infringement lawsuit originally brought by PharmaStem in
Massachusetts and any related appeals, we estimate that we could incur at least an additional $1.0
million to $2.0 million in litigation expenses. Further, if other patent infringement suits were
brought against us, our collaborators or our licensors, we or they could be forced to stop or delay
research, development, manufacturing or sales of any infringing product in the country or countries
covered by the patent we infringe, unless we can obtain a license from the patent holder. Such a
license may not be available on acceptable terms, or at all, particularly if the third party is
developing or marketing a product competitive with the infringing product. Even if we, our
collaborators or our licensors were able to obtain a license, the rights may be nonexclusive, which
would give our competitors access to the same intellectual property. In addition, payments under
such licenses would reduce the earnings otherwise attributable to the related products. We also may be required to pay substantial damages to the patent holder in the event of an
infringement. Under some circumstances in the United States, these damages could be triple the
actual damages the patent holder incurred, and we could be ordered to pay the costs and attorneys
fees incurred by the patent holder. If we have supplied infringing products to third parties for
marketing, or licensed third parties to manufacture, use or market infringing products, we may be
obligated to indemnify these third parties for any damages they may be required to pay to the
patent holder and for any losses the third parties may sustain themselves as the result of lost
sales or damages paid to the patent holder. In addition to the two PharmaStem patent infringement lawsuits we are contesting, we are aware
that PharmaStem owns an additional patent, U.S. Patent No. 6,605,275, in the cord blood
preservation field, which is the field in which we currently do business regarding Viacord and, if
approved and commercialized, our CB001 product candidate. This patent expires in 2010. We are also
aware of two patents relating to compositions of purified hematopoietic stem cells and their use in
hematopoietic stem cell transplantation, which could impact our stem cell therapeutics business. We
believe, based on advice of our patent counsel, that we do not infringe any valid claims of this
additional PharmaStem patent or of these two other patents. We cannot assure you, however, that if
we are sued on any of these patents we would prevail. Proving invalidity, in particular, is
difficult since it requires a showing of clear and convincing evidence to overcome the presumption
of validity enjoyed by issued patents. If we are found to infringe these patents and are not able
to obtain a license, we may not be able to operate our business. Any successful infringement action brought against us may also adversely affect marketing of
the infringing product in other markets not covered by the infringement action, as well as our
marketing of other products based on similar technology. Furthermore, we may suffer adverse
consequences from a successful infringement action against us even if the action is subsequently
reversed on appeal, nullified through another action or resolved by settlement with the patent
holder. The damages or other remedies awarded, if any, may be significant. As a result, any
infringement action against us would likely delay the 38




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regulatory approval process, harm our competitive position, be very costly and require significant
time and attention of our key management and technical personnel. We may be involved in lawsuits to protect or enforce our patents or the patents of our
collaborators or licensors, which could be expensive and time consuming. Competitors may infringe our patents or the patents of our collaborators or licensors.
Although we have not needed to take such action to date, we may be required to file infringement
claims to counter infringement or unauthorized use. This can be expensive, particularly for a
company of our size, and time-consuming. In addition, in an infringement proceeding, a court may
decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other
party from using the technology at issue on the grounds that our patents do not cover its
technology. An adverse determination of any litigation or defense proceedings could put one or more
of our patents at risk of being invalidated or interpreted narrowly and could put our patent
applications at risk of not issuing. Interference proceedings brought by the US Patent and Trademark Office may be necessary to
determine the priority of inventions with respect to our patent applications or those of our
collaborators or licensors. Litigation or interference proceedings may fail and, even if
successful, may result in substantial costs and distraction to our management. We may not be able,
alone or with our collaborators and licensors, to prevent misappropriation of our proprietary
rights, particularly in countries where the laws may not protect such rights as fully as in the
United States. Furthermore, because of the substantial amount of discovery required in connection with
intellectual property litigation, there is a risk that some of our confidential information could
be compromised by disclosure during this type of litigation. In addition, during the course of this
kind of litigation, there could be public announcements of the results of hearings, motions or
other interim proceedings or developments. If investors perceive these results to be negative, it
could have a substantial adverse effect on the price of our common stock. In order to commercialize CB001 or other product candidates using our Selective
Amplification technology, we may need to obtain additional license rights to third party
patents, which may not be available to us on reasonable terms, or at all. Some aspects of our Selective Amplification technology involve the use of antibodies, growth
factors and other reagents that are, in certain cases, the subject of third party rights. We have
the rights to third party patents for use of all growth factors employed in manufacturing our
current product candidates for preclinical and clinical testing, including licenses from Amgen for
SCF and Flt-3 and GlaxoSmithKline for Tpo mimetic. The media in which we amplify the cells is
available from several commercial sources. Before we commercialize any product utilizing this
technology, including CB001, we may need to obtain additional license rights to use reagents from
third parties not covered by these patents or licenses. If we are not able to obtain these rights
on reasonable terms or redesign our Selective Amplification process to use other reagents, we may
not be able to commercialize any products, including CB001. If we must redesign our Selective
Amplification process to use other reagents, we may need to demonstrate comparability in subsequent
clinical trials. The successful commercialization of CB001, or any of our other potential cell therapy
products, will depend on obtaining reimbursement for use of this product from third party
payers. If we successfully develop and obtain necessary regulatory approvals, we intend to sell our
lead product CB001 initially in the United States and the European Union. In the United States, the
market for many pharmaceutical products is affected by the availability of reimbursement from third
party payers such as government health administration authorities, private health insurers, health
maintenance 39




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organizations and pharmacy benefit management companies. CB001 and our other potential
cellular therapy products may be relatively expensive treatments due to the higher cost of
production and more complex logistics of cellular products compared with standard pharmaceuticals;
this, in turn, may make it
more difficult for us to obtain adequate reimbursement from third party payers, particularly if we
cannot demonstrate a favorable cost-benefit relationship. Third-party payers may also deny coverage
or offer inadequate levels of reimbursement for CB001 or any of our other potential products if
they determine that the product has not received appropriate clearances from the FDA or other
government regulators or is experimental, unnecessary or inappropriate. In the countries of the
European Union and in some other countries, the pricing of prescription pharmaceutical products and
services and the level of government reimbursement are subject to governmental control. Managing and reducing health care costs has been a concern generally of federal and state
governments in the United States and of foreign governments. Although we do not believe that any
recently enacted or presently proposed legislation should impact our business, we cannot be sure
that we will not be subject to future regulations that may materially restrict the price we receive
for our products. Cost control initiatives could decrease the price that we receive for any product
we may develop in the future. In addition, third-party payers are increasingly challenging the
price and cost-effectiveness of medical products and services, and any of our potential products
may ultimately not be considered cost-effective by these payers. Any of these initiatives or
developments could materially harm our business. Although we are aware of a small fraction of Viacord customers receiving reimbursement, we
believe our Viacord cord blood preservation product, like other private cord blood banking, is not
generally subject to reimbursement. However, if our potential cell therapy products, like CB001,
are not reimbursed by the government or third party insurers, the market for those products would
be limited. We cannot be sure that third party payers will reimburse sales of a product or enable
us or our partners to sell the product at prices that will provide a sustainable and profitable
revenue stream. We have only limited experience manufacturing cell therapy product candidates in connection
with our preclinical and clinical work to date, and we may not be able to manufacture our
product candidates in quantities sufficient for later stage clinical studies or for
commercial scale. We currently produce limited quantities of stem cells using our Selective Amplification and
USSC technologies. We have not built commercial scale manufacturing facilities, and have no
experience in manufacturing cellular products in the volumes that will be required for later stage
clinical studies or commercialization. If we successfully obtain marketing approval for any
products, we may not be able to produce sufficient quantities of our products at an acceptable
cost. Commercial-scale production of therapies made from live human cells involves production in
small batches and management of complex logistics. Cellular therapies are inherently more difficult
to manufacture at commercial-scale than chemical pharmaceuticals or biologics, which are
manufactured using standardized production technologies and operational methods. We may encounter
difficulties in production due to, among other things, quality control, quality assurance and
component supply. These difficulties could reduce sales of our products, increase our cost or cause
production delays, all of which could damage our reputation and hurt our profitability. We are dependent on our existing suppliers and establishing relationships with certain other
suppliers for certain components of our product candidates. The loss of such suppliers or
our inability to establish such relationships may delay development or limit our ability to
manufacture our stem cell therapy products. Certain antibodies, growth factors and other reagents are critical components used in our stem
cell production process. Our Selective Amplification process currently uses components sold to us
by certain manufacturers, and we need to establish relationships with other suppliers to
manufacture cGMP 40




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grade products for commercial sale. We are materially dependent on our suppliers
for such components. Some of these components are supplied to us by Amgen, GlaxoSmithKline and
Miltenyi Biotec, with whom we have agreements to supply SCF, Flt-3 Tpo mimetic and cGMP grade
antibodies conjugated with magnetic particles and who are our only single-source suppliers on whom
we currently materially rely. Other components, such as research grade materials that are suitable
for production of stem cells used for research and in Phase I human clinical studies, are purchased
as catalog products from vendors, such as StemCell Technologies and R&D Systems, with which we do
not have relationships. In order to continue our clinical trials and commercialize our Selective
Amplification products, we will need to establish relationships with some of these suppliers. In
the event that our suppliers are unable or unwilling to produce such components on commercially
reasonable terms, and we are unable to find substitute suppliers for such components, we may not be
able to commercialize our stem cell products. We depend on our suppliers to perform their
obligations in a timely manner and in accordance with applicable government regulations. In the
event that any of these suppliers becomes unwilling or unable to continue to supply necessary
components for the manufacture of our stem cell products, we will need to repeat certain
development work to identify and demonstrate the equivalence of alternative components purchased
from other suppliers. If we are unable to demonstrate the equivalence of alternative components in
a timely manner, or purchase these alternative components on commercially reasonable terms,
development of our products may be delayed and we may not be able to complete development of or
market our stem cell products. Material for clinical studies and future cellular products must be manufactured using
components made to a certain standard, and we may have difficulty finding sources of these
components made to this standard. In order to produce cells for use in clinical studies and produce stem cell products for
commercial sale, certain biological components used in our production process will need to be
manufactured in compliance with current Good Manufacturing Practices, or cGMP. To meet this
requirement, we will need to enter into supply agreements with firms who manufacture these
components to cGMP standards. We are currently in discussions with multiple firms who we may engage
as suppliers for these components. Once we engage these third parties, we may be materially
dependent on them for supply of cGMP grade components. If we are unable to obtain cGMP grade
biological components for our products, we may not be able to market our stem cell products. If our cord blood processing and storage facility or our clinical manufacturing facilities
are damaged or destroyed, our business and prospects would be negatively affected. We process and store our customers umbilical cord blood at our facility in Hebron, Kentucky.
If this facility or the equipment in the facility were to be significantly damaged or destroyed, we
could suffer a loss of some or all of the stored cord blood units. Depending on the extent of loss,
such an event could reduce our ability to provide cord blood stem cells when requested, could
expose us to significant liability to our cord blood banking customers and could affect our ability
to continue to provide cord blood banking services. We have a clinical manufacturing facility located in Worcester, Massachusetts that is capable
of producing stem cells for Phase I and II clinical trials. We are building out a facility in
Cambridge, Massachusetts that we intend to replace our Worcester facility and be capable of
producing stem cells for Phase II and III clinical trials and initial commercialization. In January
2005, we closed our facility in
Langenfeld, Germany and transferred all manufacturing and development activities that had been
conducted in Germany to the United States. For the next several years, we expect to manufacture all
of our stem cell product candidates in our new Cambridge facility. If this facility or the
equipment in it is significantly damaged or destroyed, we may not be able to quickly or
inexpensively replace our manufacturing capacity. In the event of a temporary or protracted loss of
this facility or equipment, we may be able to transfer manufacturing to a third party, but the
shift would likely be expensive, and the 41




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timing would depend on availability of third party
resources and the speed with which we could have a new facility approved by the FDA. While we believe that we have insured against losses from damage to or destruction of our
facilities consistent with typical industry practices, if we have underestimated our insurance
needs, we will not have sufficient insurance to cover losses above and beyond the limits on our
policies. Currently, we maintain insurance coverage totaling $20.9 million against damage to our
property and equipment, and an additional $18.0 million to cover incremental expenses and loss of
profits resulting from such damage. If we are not able to recruit and retain qualified management and scientific personnel, we
may fail in developing our technologies and product candidates. Our success is highly dependent on the retention of the principal members of our scientific,
management and sales personnel. Marc D. Beer, our President and Chief Executive Officer, is
critical to our ability to execute our overall business strategy. Morey Kraus, our Chief Technology
Officer and co-founder, is a co-inventor of our Selective Amplification technology and has
significant and unique expertise in stem cell expansion and related technologies. We maintain key
man life insurance on the lives of Marc D. Beer and Morey Kraus. Additionally, we have several
other scientific personnel that we consider important to the successful development of our
technology. Although we are not aware that any of our key employees are currently planning to
retire or leave the company, any key employee could terminate his or her relationship with us at
any time and, despite any non-competition agreement with us, work for one of our competitors.
Furthermore, our future growth will require hiring a significant number of qualified technical,
commercial and administrative personnel. Accordingly, recruiting and retaining such personnel in
the future will be critical to our success. Although we have been successful recruiting and retaining key personnel in the past, there is
intense competition from other companies, universities and other research institutions for
qualified personnel in the areas of our activities. If we are not able to continue to attract and
retain, on acceptable terms, the qualified personnel necessary for the continued development of our
business, we may not be able to sustain our operations or achieve our business objectives. We may face difficulties in managing and maintaining the growth of our business. We expect to continue expanding our reproductive health services in the United States. This
expansion could put significant strain on our management, operational and financial resources.
Currently, our only facilities abroad are offices and laboratories in Singapore. To manage future
growth, we would need to hire, train and manage additional employees, particularly a
specially-trained sales force. We plan to begin commercializing our oocyte cryopreservation
technology if and when the cryopreservation media obtains FDA clearance. In April 2005, our media
supplier received a letter from the FDA stating that a new clinical trial would be required, that
the media had been reclassified as a class 3 device and that in order to commercially market the
device in the U.S. an approved PMA would be required, unless the device was later reclassified, in
which case the media could be cleared for marketing based on a 510(k) filing. Should the media be
cleared for marketing to commercialize this product, we would be
required to institute additional and distinct sales and marketing, manufacturing and storage
capacities in addition to leveraging our existing capabilities in these areas. Concurrent with
expanding our reproductive health activities, we will also be increasing our research and
development activities, most significantly the clinical development of our lead product candidate,
CB001, with the expectation of ultimately commercializing that product candidate. Prior to our recently completed initial public offering in January, we maintained a small
finance and accounting staff because we were a private company. Our new reporting obligations as a
public company, as well as our need to comply with the requirements of the Sarbanes-Oxley Act of
2002, the 42




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rules and regulations of the Securities and Exchange Commission and the Nasdaq National
Market, will place significant additional demands on our finance and accounting staff, on our
financial, accounting and information systems and on our internal controls. We intend to add to our
accounting and finance personnel and have taken steps to proactively monitor our networks and to
improve our financial, accounting and information systems and internal controls in order to fulfill
our responsibilities as a public company and to support growth in our business. We cannot assure
you that our current and planned personnel, systems procedures and controls will be adequate to
support our anticipated growth or that management will be able to hire, train, retain, motivate and
manage required personnel. Our failure to manage growth effectively could limit our ability to
achieve our research and development and commercialization goals or to satisfy our reporting and
other obligations as a public company. If we acquire other businesses or technologies and are unable to integrate them successfully
with our business, our financial performance could suffer. If we are presented with appropriate opportunities, we may acquire other businesses. We have
had limited experience in acquiring and integrating other businesses; since our incorporation in
1994, we have acquired three businesses: Viacord in 2000, Cerebrotec, Inc. in 2001 and Kourion
Therapeutics AG in 2003. The integration process following any future acquisitions may produce
unforeseen operating difficulties and expenditures and may absorb significant management attention
that would otherwise be available for the ongoing development of our business. Also, in any future
acquisitions, we may issue shares of stock dilutive to existing stockholders, incur debt, assume
contingent liabilities, or create additional expenses related to amortizing intangible assets, any
of which might harm our financial results and cause our stock price to decline. Any financing we
might need for future acquisitions may be available to us only on terms that restrict our business
or impose costs that reduce our net income. Our competitors may have greater resources or capabilities or better technologies than we
have, or may succeed in developing better products or develop products more quickly than we
do, and we may not be successful in competing with them. The pharmaceutical and biotechnology businesses are highly competitive. We compete with many
organizations that are developing cell therapies for the treatment of a variety of human diseases,
including companies such as Aastrom Biosciences, Cellerant, Gamida-Cell, Geron, Genzyme, Neuronyx,
Osiris Therapeutics and Stem Cells. We also face competition in the cell therapy field from
academic institutions and governmental agencies. Some of these competitors, and future competitors,
may have similar or better product candidates or technologies, greater financial and human
resources than we have, including more experience in research and development and more established
sales, marketing and distribution capabilities. Specifically, Gamida-Cell, a private company based
in Israel, is developing a hematopoetic stem cell therapy product candidate similar to CB001. This
product has been evaluated in a Phase I trial. Another competitor, Osiris Therapeutics, a private
company based in the United States, has a mesenchymal stem cell product candidate made from bone
marrow that is intended for use in conjunction with transplantation of conventional bone marrow or
cord blood cells. Osiriss product
candidate has already completed Phase I testing. Either of these product candidates, and
potentially others, could have equal or better efficacy than CB001 or could potentially reach the
market more quickly than CB001. In addition, public cord blood banks may, as a result of a recent
legislative initiative, be able to better compete with our potential cell therapy products, such as
CB001. The Cord Blood Stem Cell Act of 2003, which has not yet been enacted into law, sought to
authorize up to $15 million in federal funding for a national system of public cord blood banks and
encourage cord blood donations in fiscal year 2004 and up to $30 million in fiscal year 2005 from
an ethnically diverse population. The purpose of the legislation is to create a national network of
cord blood stem cell banks that contains at least 150,000 units of human cord blood stem cells. An
increase in the number and diversity of publicly-available cord blood units from public banks could
diminish the necessity of cord blood-derived therapeutics produced with our Selective Amplification
technology. 43




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In private cord blood banking, we compete with companies such as Cbr Systems, Cryo-Cell
International, CorCell and LifeBank USA. LifeBank USA is owned by Celgene Corporation, a public
company, and may have more resources to invest in sales, marketing, research and product
development than we have. In cord blood banking, we also compete with public cord blood banks such
as the New York Blood Center (National Cord Blood Program), University of Colorado Cord Blood Bank,
Milan Cord Blood Bank, Düsseldorf Cord Blood Bank, and approximately 50 other cord blood banks
around the world. Public cord blood banks provide families with the option of donating their cord
blood for public use. There is no cost to donate and, as public banks grow in size and increase in
diversity, which is, for instance, the aim of the Cord Blood Stem Cell Act of 2003, the probability
of finding suitably matched cells for a family member may increase, which may result in a decrease
in demand for private cord blood banking. In addition, if the science of human leukocyte antigen
(HLA) typing advances, then unrelated cord blood transplantation may become safer and more
efficacious, similarly reducing the clinical advantage of related cord blood transplantation. In oocyte preservation, we expect to compete with in vitro fertilization (IVF) centers,
including Florida Institute for Reproductive Medicine, Stanford University, the Jones Institute for
Reproductive Medicine, and Egg Bank USA (through Advanced Fertility Clinic) and individual
companies offering oocyte cryopreservation, including Extend Fertility. Current and future
competitors in this field, too, may have greater financial and human resources than we have, and
may have similar or better product candidates or technologies, or product candidates which are
brought to the market more quickly than ours. Specifically, several IVF centers (including all of
those mentioned here) are already performing oocyte preservation on a limited basis, which may make
it more difficult for us to establish our product or achieve a significant market share. We anticipate this competition to increase in the future as new companies enter the stem cell
therapy, cord blood preservation and oocyte preservation markets. In addition, the health care
industry is characterized by rapid technological change, and new product introductions or other
technological advancements could make some or all of our products obsolete. Due to the nature of our cell preservation activities, harm to our reputation could have a
significant negative impact on our financial condition, and damage to or loss of our
customers property held in our custody could potentially result in significant legal
liability. Our cord blood preservation and our potential oocyte cryopreservation products are and will be
activities in which our reputation among clients and the medical and birthing services community
will be extremely important to our commercial success. This is due in significant part to the
nature of the product and service we provide. For instance, as part of our Viacord product, we are
assuming custodial care of a childs umbilical cord blood tissue entrusted to us by the parents for
potential future use as a therapeutic
for the child or its siblings. We believe that our reputation enables us to market ourselves as a
premium provider of cord blood preservation among our competitors. While we seek to maintain high
standards in all aspects of our provision of products and services, we cannot guarantee that we
will not experience mishaps. Like family cord blood banks generally, we face the risk that a
customers cord blood unit could be lost or damaged while in transit from the collection site to
our storage facility, including while the unit is in the possession of third party commercial
carriers used to transport the units. There is also risk of loss or damage to the unit during the
preservation or storage process. Any such mishaps, particularly if publicized in the media or
otherwise, could negatively impact our reputation, which could adversely affect our business and
business prospects. In addition to reputational damage, we face the risk of legal liability for loss of or damage
to cord blood units. We do not own the cord blood units banked by our Viacord customers; instead,
we act as custodian on behalf of the child-donors guardian. Thus loss or damage to the units would
be loss or damage to the customers property, a potentially unique, and depending on the
circumstances, perhaps irreplaceable potential therapeutic. Therefore, we cannot be sure to what
extent we could be found liable, 44




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in any given scenario, for damages suffered by an owner or donor
as a result of harm or loss of a cord blood unit. Since we began offering the Viacord blood
preservation product in 1994, two lawsuits have been filed against us, one regarding damage to a
customers cord blood unit because of a delay in transport to our processing facility and the other
regarding the total loss of the unit while in transit. Both cases were settled through mediation
for amounts not material to our financial results or financial condition and were substantially
covered by our insurance policies. However, we cannot assure you that any future cases could be
resolved by payment of immaterial amounts for damages or that our insurance coverage will be
sufficient to cover such damages. The manufacture and sale of stem cell products may expose us to product liability claims for
which we could have substantial liability. We face an inherent business risk of exposure to product liability claims if stem cell
products produced using our technology are alleged or found to have caused injury. While we believe
that our current liability insurance coverage is adequate for our present commercial activities, we
will need to increase our insurance coverage if and when we begin commercializing stem cell therapy
products. We may not be able to obtain insurance for potential liability arising from any such
potential products on acceptable terms with adequate coverage or may be excluded from coverage
under the terms of any insurance policy that we obtain. We may not be able to maintain insurance on
acceptable terms or at all. If we are unable to obtain insurance or any claims against us
substantially exceed our coverage, then our business could be adversely impacted. We face potential liability related to the privacy of health information we obtain from
research collaborators or from providers who enroll patients and collect cord blood or human
oocytes. Our business relies on the acquisition, analysis, and storage of potentially sensitive
information about individuals health, both in our research activities and in our reproductive
health product and service offerings. These data are protected by numerous federal and state
privacy laws. Most health care providers, including research collaborators from whom we obtain patient
information, are subject to privacy regulations promulgated under the Heath Insurance Portability
and Accountability Act of 1996, or HIPAA (Privacy Rule). Although we ourselves are not directly
regulated by the HIPAA Privacy Rule, we could face substantial criminal penalties if we knowingly
receive individually identifiable health information from a health care provider who has not
satisfied the HIPAA Privacy Rules disclosure standards. In addition, certain state privacy laws
and genetic testing
laws may apply directly to our operations and impose restrictions on our use and dissemination of
individuals health information. Moreover, patients about whom we obtain information, as well as
the providers who share this information with us, may have contractual rights that limit our
ability to use and disclose the information. Claims that we have violated individuals privacy
rights or breached our contractual obligations, even if we are not found liable, could be expensive
and time-consuming to defend and could result in adverse publicity that could harm our business. Ethical and other concerns surrounding the use of stem cell therapy may negatively affect
regulatory approval or public perception of our products, thereby reducing demand for our
products. The use of embryonic stem cells for research and stem cell therapy has been the subject of
debate regarding related ethical, legal and social issues. Although we do not currently use
embryonic stem cells as a source for our research programs, the use of other types of human stem
cells for therapy could give rise to similar ethical, legal and social issues as those associated
with embryonic stem cells. The commercial success of our product candidates will depend in part on
public acceptance of the use of stem cell therapy, in general, for the prevention or treatment of
human diseases. Public attitudes may be influenced by claims that stem cell therapy is unsafe, and
stem cell therapy may not gain the acceptance 45




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of the public or the medical community. Adverse
events in the field of stem cell therapy that may occur in the future also may result in greater
governmental regulation of our product candidates and potential regulatory delays relating to the
testing or approval of our product candidates. In the event that our research becomes the subject
of adverse commentary or publicity, the market price for our common stock could be significantly
harmed. Our business involves the use of hazardous materials that could expose us to environmental
and other liability. We have facilities in Massachusetts, Kentucky, Singapore and Germany that are subject to
various local, state and federal laws and regulations relating to safe working conditions,
laboratory and manufacturing practices, the experimental use of animals and the use and disposal of
hazardous or potentially hazardous substances, including chemicals, micro-organisms and various radioactive
compounds used in connection with our research and development activities. In the United States,
these laws include the Occupational Safety and Health Act, the Toxic Test Substances Control Act
and the Resource Conservation and Recovery Act. Although we believe that our safety procedures for
handling and disposing of these materials comply with the standards prescribed by these
regulations, we cannot assure you that accidental contamination or injury to employees and third
parties from these materials will not occur. We do not have insurance to cover claims arising from
our use and disposal of these hazardous substances other than limited clean-up expense coverage for
environmental contamination due to an otherwise insured peril, such as fire. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Investment Risk We own financial instruments that are sensitive to market risks as part of our investment
portfolio. We use this investment portfolio to preserve our capital until it is required to fund
operations, including our research and development activities. Our investment portfolio includes
only marketable securities with active secondary or resale markets to help ensure portfolio
liquidity, and we have implemented guidelines limiting the duration of investments. We invest in
highly-rated commercial paper
with maturities of less than two years and money market funds. None of these market-risk
sensitive instruments is held for trading purposes. We do not own derivative financial instruments
in our investment portfolio. Foreign Exchange Risk Transactions by our German subsidiary Kourion Therapeutics are recorded in euros. Exchange
gains or losses resulting from the translation of Kourions financial statements into US dollars
are included as a separate component of stockholders deficit. We hold euro-based currency accounts
to mitigate foreign currency transaction risk. Since both the revenues and expenses of this
subsidiary are denominated in euros, the fluctuations of exchange rates may adversely affect our
results of operations, financial position and cash flows. Interest Rate Risk We invest our cash in a variety of financial instruments, principally securities issued by the
US government and its agencies, investment grade corporate and money market instruments. These
investments are denominated in US dollars. These bonds are subject to interest rate risk, and could
decline in value if interest rates fluctuate. Due to the conservative nature of these instruments,
we do not believe that we have a material exposure to interest rate risk. 46




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ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our principal
executive officer and principal financial officer, we have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures as of March 31, 2005 and, based on
their evaluation, our principal executive officer and principal financial officer have concluded
that these controls and procedures are effective. Disclosure controls and procedures are our
controls and other procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information required to be
disclosed by us in the reports that we file under the Securities Exchange Act is accumulated and
communicated to our management, including our principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required disclosure. There were no changes in our internal controls over financial reporting during the quarter
ended March 31, 2005 that have materially affected, or are reasonably likely to materially affect,
our internal controls over financial reporting. 
 PART II  OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS PharmaStem Litigation As discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, we
were sued by PharmaStem Therapeutics, Inc. for allegedly infringing two patents relating to our
Viacord umbilical cord stem cell cryopreservation business after we rejected PharmaStems initial
requests seeking a license arrangement because we believe that we do not infringe these
patents and that they are invalid. PharmaStem filed a complaint in early 2002 against us and
several other defendants in the United States District Court for the District of Delaware, alleging
infringement of US Patents No. 5,004,681 and No. 5,192,553, relating to certain aspects of the
collection, cryopreservation and storage of hematopoietic stem cells and progenitor cells from
umbilical cord blood. In 2003, the jury ruled against us and the other defendants, Cbr Systems,
CorCell and Cryo-Cell, who represent a majority of the family cord blood preservation industry, and
a judgment was entered against us for approximately $2.9 million, based on 6.125% royalties on our
revenue from the processing and storage of umbilical cord blood since April 2000. In 2004, the Delaware Court overturned the judgment against ViaCell on the 553 method patent,
ruling that we did not infringe the patent. Regarding the 681 composition patent, the Court
initially vacated the verdict and ordered a new trial on infringement and damages (if any), in
connection with which, PharmaStem sought a preliminary injunction. However, the Court subsequently
reversed its ruling, overturning the jurys verdict of infringement of the 681 patent and denying
PharmaStems motion for preliminary injunction. On January 6, 2005, PharmaStem filed a Notice of
Appeal and a Motion to Expedite the Appeal of the Courts decision. On February 15, 2005, that
Motion to Expedite the Appeal was denied. PharmaStems appeal brief was filed on March 22, 2005,
and our appeal brief is due May 16, 2005. In August 2004, the US Patent and Trademark Office (US PTO) ordered the re-examination of both
the 553 method patent and the 681 composition patent based on the prior art. On February 2, 2005,
the PTO issued an Office Action rejecting all claims of the 553 patent as invalid over prior art. 47




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Should the US PTO find the claims of these patents to be unpatentable, then the litigation
proceedings between us and PharmaStem with respect to the unpatentable claims would cease. If the
Courts judgment as to non-infringement of the 553 or 681 patent is reversed on appeal and if we
are subsequently enjoined from further engaging in our umbilical cord stem cell cryopreservation
business, we will not be able to conduct this business unless PharmaStem grants a license to us,
which PharmaStem previously informed us that it would not do after October 15, 2004. While we do
not believe this outcome is likely, if, in the event of an injunction, we are not able to obtain a
license under the disputed patents or operate under an equitable doctrine known as intervening
rights, we will be required to stop preserving and storing cord blood and to cease using
cryopreserved umbilical cord blood as a source for stem cell products. PharmaStem also filed a complaint against us in July 2004 in the United States District Court
for the District of Massachusetts, alleging infringement of US Patents No. 6,461,645 and 6,569,427,
which also relate to certain aspects of the collection, cryopreservation and storage of
hematopoietic stem cells and progenitor cells from umbilical cord blood. By agreement of the
parties, ViaCell responded to the complaint on December 16, 2004. We continue to believe that the
patents in this new Massachusetts action are invalid and that we do not infringe them in any event.
On January 7, 2005, PharmaStem filed a Motion for Preliminary Injunction in the Massachusetts
litigation. That Motion is currently stayed. If this Motion is granted, we could be enjoined from
collecting and storing cord blood that had not been collected as of the date the injunction is
issued while the case is litigated and thereafter if we lose the case. We believe that the issues
presented in PharmaStems Motion are substantially the same as the issues presented in the Delaware
litigation and, while no assurance can be given, we believe that PharmaStems Motion will be
denied. If we are ultimately found to infringe, we could have a significant damages award entered
against us, and we could also face an injunction which could prohibit us from further engaging in
the umbilical cord stem cell business absent a license from PharmaStem on the disputed patents. We
believe the issues presented in this case are substantially the same as the issues
presented in the Delaware litigation. Accordingly, we filed a motion to consolidate the
Massachusetts case with six other actions against other defendants in a single proceeding in the
District of Delaware. On January 21, 2005, the Massachusetts case was stayed pending a ruling on
this request. On February 16, 2005, our request was granted. The cases have thus been consolidated
in Delaware. In April 2005, the US PTO ordered re-examination of some claims of the patents at issue in the
second litigation, the 645 and 427 patents, based on the prior art. A request for re-examination
of other claims of those patents was denied. The timing and order of the litigations involving ViaCell and PharmaStem are not presently
known. Decisions in the re-examination proceedings of the 681, 553, 645 and 427 patents, now
pending before the US PTO, may also affect these factors. We may enter into settlement negotiations with PharmaStem regarding our litigation with
PharmaStem. We cannot predict whether any such negotiations would lead to a settlement of these
lawsuits or what the terms or timing of any such settlement might be, if it occurs at all. Worth Litigation On May 13, 2004, we received a First Amended Complaint filed in the Superior Court of the
State of California by Kenneth D. Worth, by and for the People of the State of California, and
naming as defendants a number of private cord blood banks, including us. The complaint alleges that
the defendants have made fraudulent claims in connection with the marketing of their cord blood
banking services and seeks restitution for those affected by such marketing, injunctive relief
precluding the defendants from continuing to abusively and fraudulently market their services and
requiring them to provide certain information and refunds to their customers, unspecified punitive
and exemplary damages and attorneys fees and costs. Subsequently, we received a Notice of Ex Parte
Application for Leave to Intervene filed 48




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on behalf of the Cord Blood Foundation by the same
individual and seeking similar relief. On October 7, 2004, the Court orally granted a motion to
strike the complaint under the California anti-SLAPP statute and dismissed the complaint as to all
defendants without leave to amend. Judgment has been entered, dismissing the complaint, and
plaintiff has filed a notice of appeal and a petition for a writ of mandate. The petition has been
dismissed and the appeal is proceeding. We believe that the plaintiff is in the process of
negotiating a settlement with all defendants other than us. We are not yet able to conclude as to
the likelihood that plaintiffs claims would be upheld if the judgment of dismissal were reversed
on appeal, nor can we estimate the possible financial consequences should plaintiff prevail.
However, we believe this suit to be without merit and intend to continue to vigorously defend
ourselves. Cbr Systems Litigation On February 24, 2005, Cbr Systems, Inc., a private cord blood banking company, filed a
complaint against us in the United States District Court for the Northern District of California
alleging false and misleading advertising by us in violation of the federal Lanham Act and various
California statutes and common law and seeking an injunction from continuing such advertising and
unspecified damages. On April 13, 2005, we answered the complaint, denying Cbrs allegations, and
filed counterclaims alleging false and misleading advertising by Cbr. Our counterclaims seek an
injunction and damages, and we are evaluating Cbrs allegations and intend to vigorously defend
ourselves in this action. 
 ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS Sales of Unregistered Securities During the period from January 1, 2005 until February 9, 2005 (the effective date of our
Registration Statement on Form S-8 covering option exercises under our equity incentive plan), we
issued 93,145 shares of common stock to former employees upon option exercises for an aggregate
sale price of approximately $348,000. During the first fiscal quarter of 2005, we also granted
options to employees to purchase 13,500 shares of common stock at an exercise price of $9.00 per
share. There were no underwriters employed in connection with any of these transactions. Each
option grant and stock issuance was deemed exempt from registration under the Securities Act under
Rule 701 promulgated thereunder, because the security was offered and sold pursuant to either a
written compensatory plan or a written contract relating to compensation. Use of Proceeds from Registered Securities Our common stock has been traded on the NASDAQ National Market System under the symbol VIAC
since January 21, 2005. Prior to that time there was no established public trading market for our
common stock. In connection with our initial public offering, we registered shares of our common stock under
the Securities Act of 1933, as amended. Our registration statement on Form S-1 (Reg. No.
333-114209) was declared effective by the SEC on January 19, 2005. The offering commenced as of
January 20, 2005. 8,625,000 shares of our common stock registered were sold in the offering. The
offering did not terminate before any securities were sold. We completed the offering on January
26, 2005. Credit Suisse First Boston and UBS Investment Bank were the managing underwriters. All 8,625,000 shares of our common stock registered in the offering were sold with an initial
public offering (IPO) price per share of $7.00. The aggregate purchase price of the offering was
$60,375,000, of a maximum potential registered aggregate offering price of $92,000,000. The net
offering proceeds to us were $53,291,000 after deducting total expenses related to the issuance and
distribution of the IPO common stock of $7,084,000 consisting of: 49




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
    $2,700,000 in legal, accounting and printing fees;
    $4,200,000 in underwriters discounts, fees and commissions; and
    $184,000 in miscellaneous expenses. No payments for such expenses were made directly or indirectly to (i) any of our directors,
officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity
securities or (iii) any of our affiliates. During fiscal quarter ended March 31, 2005, the Company used the net proceeds of the IPO in
the following manner:  
    $15,509,760 to pay off all outstanding principal and interest on promissory notes
held by funds affiliated with MPM Asset Management LLC, the manager of which serves on
the Companys board of directors;
    approximately $2,548,000 toward working capital and fixed assets, including our
clinical trials for CB001 and preclinical research and development activities relating
to our product candidates; and
    approximately $35,233,240 in temporary investments. Other than repayment of the promissory notes, no payments of such proceeds were made directly
or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning
10% or more of any class of our equity securities or (iii) any of our affiliates. There has been
no material change in the planned use of proceeds from our initial public offering as described in
our final prospectus filed with the SEC pursuant to Rule 424(b). ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 
 ITEM 5. OTHER INFORMATION 
 Establishment of Executive Management Bonus and Equity Awards for 2004 and Base Salary and Bonus
Potential for 2005 In February 2005, the Compensation Committee of the Board of Directors of ViaCell awarded Marc
Beer, Chairman and CEO, a cash bonus of $113,832, set his base salary for 2005 at $350,000 and set
his 2005 target bonus level at 60% of base. It also awarded the following cash bonuses to, and set
the 2005 base salary for, each of the Companys named executives as follows: Name and Position
    
    2004 Cash Bonus Award
    
    
    2005 Base SalaryCristoph Adams
    
    $38,690
    
    
    $233,018Stephen Dance
    
    $33,700
    
    

    $ 245,000Kurt Gunter
    
    $28,860
    
    
    $233,028Stephan Wnendt
    
    $55,050
    
    
    $230,000
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All bonus awards were based on achievement of goals and benchmark data. Target bonus levels
for these four executives for 2005 were set at levels ranging from 20% to 32% of base salary. In addition, on April 27, 2005, the Board approved the Compensation Committees recommendation
to grant Messrs. Adams and Gunter each an incentive stock option to purchase 25,000 shares of
ViaCell common stock at an exercise price of $7.25 per share (the closing price of our common stock
on the Nasdaq National Market on the date preceding the date of grant), vesting quarterly in
sixteen equal installments with respect to the underlying shares commencing on May 18, 2005 and
continuing on each three month anniversary of such date. 
 ITEM 6.EXHIBITS See the Exhibit List following the Signatures page below. 51




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SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized. VIACELL, INC.Date: May 13, 2005
    
    /s/ Marc D. BeerMarc D. BeerChief Executive Officer(Principal Executive Officer)Date: May 13, 2005
    
    /s/ Stephen G. DanceStephen G. DanceChief Financial Officer(Principal Accounting Officer)
 52




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EXHIBIT INDEX No.
    
    Item4.4(1)
    
    Form of Warrant issued to former investors in the Companys Series
J convertible preferred stock on January 26, 2005 to purchase up to
a total aggregate amount of 2,190,000 shares of common stock.10.1
    
    Development Agreement dated January 24, 2005 by and between the
Company and Miltenyi Biotec GmbH. *10.2
    
    Supply Agreement dated January 24, 2005 by and between the Company
and Miltenyi Biotec GmbH. *31.1
    
    Chief Executive Officer Certification Pursuant to Rule 13a-14 of
the Securities Exchange Act of 1934, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Chief Financial Officer Certification Pursuant to Rule 13a-14 of
the Securities Exchange Act of 1934, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Chief Executive Officer Certification pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Chief Financial Officer Certification pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
   (1)
    
    Filed as an exhibit to the Companys Annual Report on Form 10-K for the fiscal year ended
December 31, 2004 and incorporated herein by reference.*
    
    The exhibit has been filed separately with the Commission pursuant to an application for
confidential treatment. The confidential portions of this exhibit have been omitted and are
marked by brackets ([**]). 53